Interest rates and inflation: a view from the margin

There are mutterings in economics circles in the UK, pressing for a rise in interest rates to control inflation. The Retail Prices Index rose 4.8% in 2010, resulting in an uncomfortable tightening of household budgets because average earnings increased much less, by 2.1% overall in the year to end-November 2010, 1.9% in the private sector and 2.4% in the public sector.

Now in 2011 we face drastic job cuts across the public sector, higher taxes — starting on January 4th with Value Added Tax jumping from 17.5% to 20% — and a painful squeeze on benefits, all in the name of cutting our budget deficit and ultimately our national debt, which exceeds £1 trillion (see That is over  £16,000  for each of the approximately 62.2 million — of all ages from new-born babies to centenarians — living in the UK.

Higher interest rates would begin to compensate savers for the inflationary consequences of quantitative easing — £200 billion created by the Bank of England — but at the cost of further misery for households burdened with mortgages (when property prices are no longer rising), and with unsecured loans and credit card debt. The UK in 2011 is a hostile environment for workers, let alone workers wanting pay rises.

I think the arguments of neo-classical economists, that inflation results from an excess of money in circulation, and that interest rates are the main weapon to bludgeon inflation back into line, apply more in a world where nation states are in ultimate control of finances, than in the current situation of global capital and commodity flows.

If one country, say the UK, raises interest rates, inflation will barely be affected because the prices of essential commodities — oil, gas, minerals, foodstuffs — are beyond our control, and determined more by their inherent availability (or scarcity) than by the purchasing capacity of UK buyers.  It’s a lot more complicated than economic formulae suggest.


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