David Gauke: Four snake oil alternatives at even higher interest rates. And the truth is: there is no alternative. – News Block

David Gauke was a former Justice Secretary and was an independent candidate for South West Hertfordshire in the 2019 general election.

There are multiple consequences of higher interest rates. One of which is that various bad ideas are gaining ground as proposals are put forth that are supposed to prevent the pain to come. Here are four examples.

The first bogus argument starts with the premise that our inflation problems are not caused by excess demand but by inadequate supply, caused by Covid and Brexit disruption etc. So, the argument goes, the way to deal with inflation is not to reduce demand but to improve supply.

There is, of course, an element of truth to this, in the sense that tight supply is the source of many of the problems. If we could remove supply constraints, such as the absence of workers, we would have fewer problems with inflation. Policies that increase the supply of labor, whether it’s training, welfare reform, occupational health care, or immigration, can ultimately help reduce inflation. But these are not measures that are likely to have an immediate impact on inflation.

In other words, even if our problems result from restricted supply and not increased demand, the situation is still one of demand exceeding supply. To address this quickly (and not addressing this quickly will create more problems) we need to reduce demand.

The second set of bad ideas is to focus on the symptoms and not the causes. When prices rise to adjust to a new balance between supply and demand, the companies that raise prices are blamed and accused of speculation. There was a lot of excitement last week when the International Monetary Fund signaled that corporate profits had risen. “Greedflation” is the buzz phrase when big business, particularly supermarkets, is blamed for raising prices. As it happens, the IMF was referring to europeand the evidence that corporate profits grow in the UK in the same way is not entirely convincing.

The argument also misses two more important points. Companies making higher profits (or, for that matter, workers receiving high wage premiums) are a consequence of inflationary pressures, not the root cause of them. And market signals are helpful in allocating resources efficiently. For example, when supply constraints force prices up in a particular sector, the incentives created by higher prices will help address the problem.

Governments must ensure that markets are competitive, but encouraging companies to ignore supply and demand when setting prices and acting against their interests is not an effective method of controlling inflation. Some advocate going further and imposing price controls. At best, this always turns out to be ineffective and has unintended consequences. At worst, price controls result in disastrous shortages. Politicians and central bankers should not blame companies that operate in competitive markets for the prices they charge.

The reality is that demand has to be reduced, and the best tool at the Bank of England’s disposal is to raise interest rates. The consequences of higher interest rates are, of course, not evenly distributed. For those with large mortgages, at least once outside of their fixed rate, the news is actually very bad. If we assume that landlords will pass higher interest costs on to tenants (and this is a questionable assumption), then tenants can pay higher rents. But for those who own their home, this will not have a direct impact and, if they have savings, it will benefit them.

Unsurprisingly, this has led to calls for protection for mortgage holders. Discouraging foreclosures, for example, by allowing mortgage holders to switch to interest-only mortgages may be sensible, but other ideas make up our third group of dumb ideas.

The Lib Dems, reverting to their traditional position of trying to bribe the middle classes with their own money, were quick to catch on to the problem and advocated for taxpayer-funded grants for those struggling to pay their mortgage. Some conservative parliamentarians have called for the return of MIRAS (mortgage interest relief at source) that was part of our tax system until 1999.

These policies can be popular. One can see why the beneficiaries would welcome them, but they would still be a mistake. They would reduce the anti-inflationary effectiveness of higher interest rates, perhaps raising interest rates even higher, hurting business investment.

There is also a moral hazard problem, as people would take on higher levels of debt under the assumption that the state would bail them out if things went wrong. Related to this, these policies would further distort the market for savings towards housing rather than more productive investment. And the support would not be progressively targeted: much of the support would end up going to middle-income and even high-income people.

If we wanted to redistribute the pain, and it has to be said that the pain will be largely concentrated on mortgage holders, we could use fiscal measures to try to take some of the heat off the economy. The Government is trying to do this through strict control of public sector wages, although this has the consequence that the public sector is not competitive in terms of hiring and retaining staff. Tax hikes are already taking place (with threshold freezes). Some argued that the April 2022 increase in national insurance contributions (later cut) risked weakening demand and threatened a fragile economy. That argument now seems wrong; our post-Covid, post-Brexit economy was overheating.

To protect mortgage holders from even higher interest rates, the government could undertake a larger tax adjustment of some kind. In general, governments should be wary of relying too heavily on fiscal policy to tackle inflation (getting the timing right is immensely difficult) but, at the very least, fiscal policy should not run counter to policy. monetary. Big fiscal easing while inflation is high, like big tax cuts, would make things worse.

The fourth example of an increasingly fashionable bad idea is that we should abandon an independent central bank and return monetary policy to the Treasury. Yes, the Bank of England hesitated too long before raising rates, but that doesn’t mean the whole model is discredited.

It is true that Rishi Sunak, as chancellor, was quicker than many to worry about inflation when he was chancellor, but the market perception will continue to be that governments will be more reluctant to administer hard drugs than central bankers. Undermining independent economic institutions comes at a high cost, as Liz Truss has shown. To maintain market confidence, interest rates would have to rise and stay high for longer if politicians were in direct control of monetary policy.

The problem for the government is that once it discards all the illusions that exist about inflation, it is still left with a big problem and a painful solution. We should try to address supply constraints, but this will not quickly address inflation. Inflation is not the fault of greedy big business and cannot be regulated. We cannot protect everyone from the pain inflicted by effective anti-inflationary measures, even if we could redistribute it somehow through highly unpopular policies. Changing the institutional arrangements of the Bank of England will almost certainly make matters worse.

Getting inflation out of the system is going to hurt, and there’s no plausible way around it. This is the essence of the Prime Minister’s message to the nation. He is telling the truth, even if the country is unlikely to be grateful to hear it.