A Recipe for Recession: What Does the Bank of England Think It's Doing?

Richard Murphy and Danny Blanchflower examine the link between interest rates, inflation and recession, and ask is the Bank of England either ignorant or in the grip of dangerous groupthink?

The Bank of England on 1 February 2024 as interest rates remained unchanged. Photo: Vuk Valcic/Alamy

The Bank of England announced on 1 February that it was leaving the UK base interest rate unchanged at 5.25%.  It followed the US Federal Reserve and European Central Bank in doing so. In each case, rates were held despite the inflation rate in the respective territories tumbling and being expected to fall much further very soon. Unusually, there were even two votes for a rate rise along with one for a cut.  In that case what drives this seemingly perverse situation, and what might the consequences and desired courses of action be?

The first thing to note is that lessons from history tell us that there never was a reason for any of these central banks to raise their interest rates in response to rising inflation.  Inflation disappears on its own. Historical data shows that every increase in inflation has an exogenous cause, like a pandemic, a war, or a related supply chain crisis, and that the impact of these things always passes quite quickly. That means that inflation (but not prices) always falls quite rapidly a year or so after such events, just as has happened on this occasion. Increased interest rates had nothing to do with that current decline, most especially as their economic impact always arises well after they are announced.

Second, that necessarily means that the impact of the rate rises we have already suffered is has yet to work through the economy and slow it further. And since their sole purpose is to reduce demand, slow growth, push up unemployment and so reduce wages, the risk of recession is, right now, very real. It is hardly surprising most people feel that we are at or near that state now.

Third, the Bank of England paranoia about wage rises currently exceeding the inflation rate, which apparently is motivating their decision to continue high interest rates, is absurd. That’s partly because inflation is not caused by wage rises; it’s caused by price rises. It’s also because overall wage changes always lag behind inflation as people, quite reasonably, try to make up for what they have lost as a result of price inflation. And it is absurd because wages really are way behind both inflation and productivity growth in many parts of the economy at this moment and increasing them is essential if we are to get out of the economic mess we are in and avoid a deep recession. 

What is more, there is plenty of room for business rather than labour to bear this cost of paying higher wages. Shareholders and CEO pay could easily take the strain as both have done well out of the economy for decades.  Making them pay would not just be fair, it would also recognise that higher unemployment lowers wellbeing much more than inflation does.

Fourth, people are hurting.  There is evidence that the wellbeing of the young, especially young women, has been declining fast and children's health has deteriorated.  A recession, which the Bank of England might induce, makes the health of the nation worse, especially for the most vulnerable.  When the government is suggesting that a new round of austerity is coming at a time when local authorities are close to bankruptcy, public services are close to collapse and NHS waiting lists are rising again, it is beholden on the Bank of England to not make matters worse. Enough is enough.

So, why is it doing this? There are a number of possibilities.

Does it want to, somehow, be proved right by delivering the recession it always said would be required to beat inflation?  This would hurt struggling people when they are about to be hit by austerity that has no economic purpose at all.  If this is the goal it is just designed to hurt the poor.

Or does it have no idea how the economics of inflation really work and is blundering on regardless?

Or, maybe we’re just seeing a bunch of bankers who really do think that high interest rates are good for the City and the wealthiest people whose interests that City serves, meaning that they presume that they must be good for the country as a whole, because these are the people that they think matter.

And it could just be that they are in the grip of the most dangerous groupthink, as certainly happened amongst central bankers prior to 2008 when they missed the onset of the Great Recession. 

Whichever option is chosen they are wrong, and two things are required. One is very rapid interest rate cuts to avoid the risk of a very serious recession that is otherwise likely. We may be too late to stop that already, but that means that rate cut must get done.

The other is to either bring interest rates back under central government control. It’s either that or the Bank of England must be made more broadly accountable, and not just for inflation but also employment and progress on climate change. But that will require that trade unionists, pensioners, small businesses, and heterodox economists also get a look in at the Bank. Then it might just serve us all, and not just a few in society.

Is that too much to ask? Probably.