I wrote this tweet yesterday:
Suppose we have the highest inflation except for Argentina and South Sudan because the Bank of England has forced companies to raise prices to cover the higher cost of debt. Since it is not wages that drive inflation, could this be the answer? https://t.co/IHKdtaegnx pic.twitter.com/ogJL2OacmU
—Richard Murphy (@RichardJMurphy) May 27, 2023
The FT article said:
My speculation is simple.
First, we know that inflation occurs because companies raise prices.
Second, we are told (contrary to much evidence) that profits are not increasing.
So third, they must be increasing prices because their costs are increasing. Those costs come in three forms:
- Purchased in goods and services.
- Interest financing costs.
We know that commodity prices are falling almost universally. I have documented that.
And we know that wages are lagging behind inflation, lagging far behind, so they can’t be at fault here.
So what about the interest? The Bank of England is raising rates as fast as it can and is determined to keep rates as high as possible. Its obvious objective is to create positive long-term real interest rates for the first time since before 2008. Suppose that rational firms have realized this and increase their costs to cover these anticipated increases in interest costs, which are a part important part of your expenses. Interest costs represent 30% of the income of water companies, for example, although they are a bit extreme. For companies, doing this would be totally rational.
But that would mean we have an interest rate/inflation spiral in the UK driven by the Bank of England and the policies it is supposedly putting in place to address inflation, when (as they say we should) we take future expectations. consider.
I am suggesting that this is at least plausible. Given the Bank’s denial of other possibilities, or the IMF’s denial of the possibility of wage/inflation spirals, among others, and in the absence of other variables that might now have a rational impact, it seems to me that this is a one of the best explanations for the current inflation now. Firms now rationally expect their interest costs to remain high in the future and raise prices accordingly.
I suspect the Bank denies this, but they have already admitted that their inflation models based on their own understanding of the subject don’t work, so little thought should be given to that.
Instead, it’s time to cut rates and eliminate the only excuse companies have for raising prices because interest rates are the only cost expected to remain high—and excessive—from now on.