Did someone say inflation?

The Bank of England’s latest plans to raise interest rates to combat inflation makes me wonder whether our economists are either totally ignorant or simply don’t give a crap about every day people.

Economics is complex – cynics might argue intentionally so. Inflation on the other hand is not particularly complex. And there ought to be a basic publicly-recognised litmus test and response on how we deal with inflation. One that’s easy for normal non-economist folk to understand.

The litmus test would be based on this question: Is the {current} inflation primarily driven by supply or demand?

If inflation is primarily demand side, ie the stock market is rising, markets are healthy, cash is in surplus, businesses are hiring trying to fulfil demand, wages are increasing, and inflation is rising relatively evenly across consumer and asset markets, then the economy might be a little too hot, and raising interest rates a bit is probably a decent idea to cool things down and bring things the economy back towards equilibrium. 

If inflation is supply side, ie there are serious global events (eg wars, natural disasters and pandemics), supply chain disruptions, price instability in global energy and commodity markets, people out of work, cash is tight, payment defaults are rising, and inflation is rising unevenly across different consumer markets, then the economy is obviously not overheated.

This is clearly the case right now. So then what the chuff do economists think will happen if they raise interest rates? What happens when you cool an economy that is already in shock?

Increased mortgage and credit card interest repayments will put further strain on the middle classes. And probably more significantly it will be a major rug-pull on businesses that have used debt to keep a healthy working capital balance. Making debt unaffordable or unattractive to businesses is not a smart move when the economy is in the state it is right now. It’s going to lead to businesses tightening their belts, which translates to people being laid off. And generally those laid off first tend to be the lowest paid, the working classes. Less consumer spending in the middle classes. More unemployment in the working classes. Stagflation.

Naturally, the political response to this – while in the short-term may hopefully see a bit of targeted fiscal stimulus and social support – in the longer term is going to see a return to austerity politics. That’s increased slashing of already-lean services that the majority of us rely upon, and that especially protect the most vulnerable.

In short, raising interest rates will not help this time. It will makes things worse. Potentially a lot worse. That’s both because cooling an economy already in shock is a terrible idea, but also since after 12 years of Conservative government, there isn’t much meat left on the bones for austerity to pick at either. We are walking ourselves into a very challenging corner. Economists need to be careful and stop blindly following dogmas that were dreamed up in different times. But as the adage goes: If your only tool is a hammer, every problem begins to look like a nail.