Last week, the Monetary Policy Committee, the Bank of England’s rate-setting body, decided to hike the basic interest rate by a quarter per cent. At 0.75% it still is very close to the all-time low and certainly far below any sort of inflation-fighting terminal interest rate. Nevertheless, comments from the Bank were relatively dovish. Members acknowledged that inflation will rise due to external price pressures, and there’s precious little they can do about it. So why would any central bank raise rates at all if inflation can’t be fought off?
The theory says that higher rates should reduce inflation pressures via many mechanisms.
Higher rates could reduce demand for houses and help control prices. Reducing the heat from the housing market would reduce people’s wealth and deter some spending and demand. Of course, since inflation is external and can’t really be fought off, consumers still have a choice between keeping their cash and lose 5%-7% per annum, or try to invest it somewhere they know, like the housing market.
Higher interest rates could deter consumers from leveraging up and increasing demand. But twelve years of secular stagnation tell us that consumers didn’t leverage up during a decade of zero rates. They would do so now, with bills spiking and geopolitical instability peaking?
Higher interest rates should also deter companies from leveraging up. This makes more sense. Lower leverage means slower business expansion, which in theory could cap prices. But the problem companies face is one of inputs. How would higher rates prevent them from passing on a portion of the increase onto the consumers? Input prices are so sharp that even in a perfect competition environment, price rises would be warranted.
Inflation is external and can’t be controlled. It is the confluence of post-pandemic supply chain disruptions exacerbated by shortages due to sanctions on Russia. It will rise as global companies compete for diminishing resources. It will drop when production is, somehow, restored or equilibrium otherwise reached. None of these can be controlled by the Bank of England.
When the US Federal Reserve, the world’s de facto central bank, does not have a way to control inflation, how can the Bank of England hope to make a difference? In an interconnected world, its decisions are much less relevant to inflation than in the decades past. At best, the institution can make an effort to keep some homes affordable. That is the real extent of its reach. High levels of government debt ensure that interest rates won’t rise very high. At worst, its decisions may hamstring the post-pandemic economic recovery.
The world is globalised. A civil war in Syria causes a huge political refugee problem in Germany. The outcome of a battle in Yemen can reverberate across energy prices globally. Russia attacking its former satellite state affects the European and the American economy, even if they are not directly embroiled in the conflict. Meanwhile, the economic consequences are far worse than what the Russian president accounted for. In a globalised, Dollar-dominated world, there is no such thing as a “Fortress Economy”, a lesson Mr. Putin is currently learning. No “taking control”.
A cynic would argue that control is an illusion. History has always moved on the decisions of the heads of the few great powers, and it is for smaller countries and those far removed from power to accept the consequences. “Theirs is but to do and die”. For all the glory and renown the UK earned during the Battle of Britain, history might have been very different if Admiral Yamamoto had not sneaked an attack on Pearl Harbour. In his own biography, Winston Churchill said on the day of the event: “Being saturated and satiated with emotion and sensation, I went to bed and slept the sleep of the saved and thankful”.
A less cynic would still see the problem of managing a country in a globalised world. It’s the economy that’s globalised. It’s interaction and culture. Even religion doesn’t divide people as much anymore. But narratives are still national. Borders are national. Laws and, above all, governments are national. The “national” and “international” are at war with each other.
In the movie “The Network” (1976), TV Network president Arthur Jensen chastises anchorman-turned-revolutionary Howard Beale: “You are an old man who thinks in terms of nations and peoples. There are no nations. There are no peoples. There are no Russians. There are no Arabs. There are no third worlds. There is no West. There is only one holistic system of systems, one vast and immense, interwoven, interacting, multivariate, multinational dominion of dollars. Petro-dollars, electro-dollars, multi-dollars, reichmarks, rins, rubles, pounds, and shekels. It is the international system of currency which determines the totality of life on this planet. That is the natural order of things today.” Probably the only thing which stops any internet user from understanding this, is heuristics bequeathed by the perception of the nation-state taught in school.
Mr Putin in 2019 said that the international liberal order has become obsolete. Other autocrats around the world might share his opinion. So he challenged it. The sprawling consequences of his war pose unequivocal proof that globalisation, the mechanism behind the global liberal order, is alive and kicking.
Either governments and institutions find ways to evolve with it, or they face the same obstinate obsolesce and perhaps authoritarianism that now threaten the former superpower that is Russia.
The old “right” and “left” divisions are no longer relevant. They were invented for nations transitioning from monarchy into democracy. Today, it’s all about embracing globalisation versus shutting the door and hoping the worst will pass by. Eastern despots and western populists are a product of that question and, counterintuitively, more relevant than most politicians out there. This is the secret to their perseverance. Their approach is to try and put the globalisation genie back into the bottle. To turn back the clock when things made sense.
We should not be too quick to judge what is right and wrong, what is doable and what not. To believe that turning back progress is folly. Fifteen hundred years of “Dark Ages” prove that history can be dialled back. Ultimately, for our lifetimes at least, those who win will also paint themselves “at the right side of history”. And that battle is still waging.