Raising interest rates won’t solve inflation

Interest rate rises transfer wealth from the public to rentiers

Prem Sikka is an Emeritus Professor of Accounting at the University of Essex and the University of Sheffield, a Labour member of the House of Lords, and Contributing Editor at Left Foot Forward.

There is “no alternative to Bank interest rate rises to calm inflation”, says UK Chancellor Jeremy Hunt. This is the wrong policy that squeezes disposable incomes, just as millions are struggling to make ends meet. It transfers wealth from the masses to rentiers, increases inequalities and erodes possibilities of building a sustainable economy.

The theory of higher interests for controlling inflation assumes that people have too much cash. Higher interest rates force people to spend more on mortgage, loans and overdraft, and thus reduce the cash available to buy goods and services. Because of the liquidity squeeze, people may defer or don’t buy non-essential things. Altogether, this dampens demand and reduces pressure for price rises.

This theory has little credence. Under the weight of the government’s austerity policies, the UK rates of inflation, measured by the consumer price index, have been relatively low, declining from 4.464% in 2011 to 0.040% in 2015. It began to escalate from May 2021 (2.115%), hit 11.052% in October 2022, declining to 8.658% in April 2023.

The interest rate has increased from 0.25% in December 2021 to 3.00% in December 2022; rising to 4.25% in March 2023 and 4.50% in May 2023. Supporters of the theory claim that interest rate hikes work. They ignore the fact that inflation has dipped because massive hikes in energy bills made twelve months ago have dropped out of the calculation.

Higher interest rates do not tackle the main cause of inflation – corporate profiteering. Profit margins at large corporations have escalated, enabling the rich to become richer. The richest 50 families have more wealth than the bottom half of the UK population (33.5 million people). In 1989, a person classified as rich by the Sunday Times Rich List had 6,000 times more wealth than the average person. In 2023, it is 18,000 times. Since 2020, the wealthiest 200 families have seen their wealth increase in real terms by 22%.

Wage growth is not the cause of inflation. The real average wage of workers has remained unchanged since 2005. Workers’ share of gross domestic product, in the form of wages, has declined from 65.1% in 1976 to around 50% in the first quarter of 2023. Some 21 million adults have annual income of less than £12,570.

A quarter of UK adults have less than £100 in savings. Almost a third of British adults have saved nothing in the last twelve months. The poorest can’t secure bank loans and overdrafts and turn to pawnbrokers who are charging interest rates of 80% to 200%.

The high interest rate policy is making the poor even poorer and cannot check profiteering. Higher interest rates force people to hand more of their income to banks. It forces them to pay more for mortgages and rents. Millions will not be able to buy a home. Higher interest rates affect business costs and increase the price of food, transport and other essentials. People cut discretionary spending on cafes, restaurants, pubs, cinemas, theatres, travel and other non-essentials, leading to loss of jobs and economic activity.

The main beneficiaries of the higher interest policies are banks and wealthy elites. Without any additional effort or investment, banks make higher profits. The government pays more to finance public debt, benefitting banks and wealthy elites. Within the tax and spend logic prevalent in neoliberal economies, this reduces the amount that the state can spend on public services. So the government has hiked taxes to a 70-year high, and public services remain in poor shape.

Higher interest rates transfer wealth to the finance industry, which in turn pays out higher dividends and executive pay to wealthy elites. They may speculate on commodities; purchase securities, foreign holidays and second-homes; buy antiques, artworks and imported expensive cars, but that does not help to build a sustainable economy.

It may be argued that higher interest rates reward savers, assuming that banks hike the rates offered to savers which is not always the case. In any case, a large section of the population does not have much in savings. Those who have savings and other financial assets become richer, exacerbating income and wealth inequalities.

The government needs to tackle the cause of inflation – that requires curbs on profiteering. Price control on essential goods and services are needed.  Neoliberals love competition. So, the government could encourage it to curb profiteering by breaking-up banks, supermarkets, agri-businesses and other monopolistic entities.

Government could levy additional taxes upon corporations and the rich to remove cash slushing in the economy. This can be done by using a financial transaction tax, a wealth tax, increasing taxes on capital gains and dividends, and a 100% windfall tax on excess profits made by banks, supermarkets, energy and other companies. This not only removes cash from those who have the most but also replenishes the public purse. This also reduces the cost of servicing public debt. It spares agony of interest rates to low/middle income households and checks widening inequalities.

Higher interest rates are a political choice, not an economic necessity. The government policy of hurting low/middle income households is destructive and does not check profiteering, which is the root cause of inflation.

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