The Bank of England has chosen to destroy jobs, because this is the foreseeable effect of its decision to raise interest rates.
This is because higher interest rates reduce inflation largely by depressing demand. At the margin, they raise the cost of capital and thus deter companies from investing and expanding. And in raising borrowing costs they also (again at the margin) deter customers from borrowing and spending and encourage them to save. The upshot is that they reduce demand and therefore employment.
Granted, these effects are small. The Bank’s own research estimates that a quarter-point rise in Bank rate eventually cuts output by less than 0.2 per cent, implying a loss of less than 50,000 jobs which is less than the sampling error in estimates of employment. Most of the rise in unemployment the Bank expects in coming months will come from the slowdown that would happen anyway, rather than from its own actions. However, with the Bank warning that “some degree of further tightening in monetary policy may still be appropriate in the coming months” it will add to the harm of that slowdown. For some people the Bank is going to make the cost of living crisis much worse.
You might think this is perverse. Inflation now is largely the result of soaring oil and gas prices, for which higher UK interest rates are close to irrelevant. They have only a minute effect upon the global demand for gas and oil and do nothing to increase their supply. In fact, at the margin, higher rates might reduce investment in renewable energy (not just by raising the cost of capital but also by reducing expected aggregate demand) and thereby prolong our dependence upon despots and rentiers.
You might also think the move unnecessary. Although economists hope that households will respond to the squeeze on real incomes by running down their savings, some will rein in their spending. If enough people heed Environment Secretary George Eustice’s advice to switch to value brands, retailers will have to hold prices down. That will eventually reduce inflation anyway.
Nevertheless, there is a justification for the Bank of England’s move. Higher oil and gas prices have reduced the economy’s supply potential: some companies that were profitable have ceased to be so and thus will close or shrink. Because inflation is determined by the balance of supply and demand, this requires that demand must fall in line with supply if inflation is to be contained. The Bank’s move will help achieve this.
Even if this justification is correct, it does nothing to solve more fundamental economic problems. In the near term, we need support for those who are struggling with their bills. This is not mere charity: higher incomes mean higher spending and hence corporate profits. In the longer term we need to accelerate the shift away from dependence upon oil and gas. And we also need to raise productivity growth as this is the only way to sustainably raise real incomes. All these require a mix of fiscal policy and supply-side policies.
Monetary policy, however, can achieve next to nothing here. For all the attention it gets, there is remarkably little it can do to address our deeper economic issues.
