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 increase prices to cover the increased cost of debt? As it isn't wages that are driving inflation, could this be the answer? https://t.co/IHKdtaegnx pic.twitter.com/ogJL2OacmU
— Richard Murphy (@RichardJMurphy) May 27, 2023
The FT piece said:
My speculation is a straightforward one.
First, we know that inflation happens because companies increase prices.
Second, we are told (contrary to much evidence) that they are not increasing profits.
So, third, they must be increasing prices because their costs are increasing. Those costs come in three forms:
- Bought in goods and services.
- Labour.
- Interest financing costs.
We know raw material prices are almost universally falling. I have documented that.
And we know wages are lagging inflation, being a long way behind, so they cannot be to blame here.
So, what about interest? The Bank of England is putting up rates as fast as it can and is determined to leave rates as high as possible. Its obvious goal is to create long term positive real interest rates for the first time since pre-2008. Suppose rational businesses have noticed this and are putting up their costs to cover these anticipated interest cost increases, which are a major part of their expenditure? Interest costs account for 30% of the income of water companies, for example, although they are a bit extreme. For business to do this would be entirely rational.
But that would mean that we have an interest rate / inflation spiral in the UK that is being driven by the Bank of England and the policies it is supposedly putting in place to tackle inflation, when (as they say we must) we take future expectations into account.
I am suggesting that this is at least plausible. Given the Bank's denial of other possibilities, or the denial of the possibility of inflationary wage / inflation spirals by the IMF, amongst others, and in the absence of other variables that can now be having rational impact, this one seems to me to be one of the best explanations for ongoing inflation now. Business is now rationally expecting its interest costs to remain high into the future and is increasing prices accordingly.
I suspect the Bank to deny this, but they have already admitted their models of inflation based on their own understandings of the issue do not work, so little weight should be given to that.
Instead it's time to cut rates and remove the only excuse businesses have to increase prices because interest rates are the only cost expected to remain high, and excessively so, from now into the future.
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So, third, they must be increasing prices because their costs are increasing. Those costs come in four forms:
Bought in goods and services.
Labour.
Interest financing costs.
Taxes.
It comes to something when a tax expert misses all time high taxes and compliance costs off a list
We are doomed, I tell ya.
Tax is not a cost
It is a distribution
And you are a troll
Richard,
Absolutely spot on.
Thank you for that list.
I now have a better understanding of how interest rates affect business. I sort of knew it, but didn’t [if that makes sense]. It also helps me understand other pieces you’ve written on interest rates.
This is the kind of open ended, questioning approach I like. Your case is persuasive Richard. The labour cost lag is clear, because the Government is squeezing labour costs where it can, and those who believe private sector labour costs are the reason, have to show private sector profitability has been badly hit. This does not seem to be the case, indeed in some cases record windfall profits are being made. At best we do not know the extent of windfall profits being made.
At the same time, the Conservatives have turned full circle in fifty years; Sunak is the new Heath; we are back to price controls. This at least suggests even the Conservatives suspect the food industry somewhere in the chain (probably retail) is making excessive proft, rather than being cost constrained. Asking a serious cost inflation burdened business to operate price controls would be an invitation to go bust.
More signs neoliberals have lost their nerve and minds; the theory is unravelling spectacularly. Sunak is expensively, but clearly not critically educated: he is trained, a machine operative, he simply presses the buttons provided by the Neoliberal Text he learned by rote. He doesn’t understand how the machine works. Nor does the BoE; and although at least the BoE know they do not understand what they are doing, they are less operatives than automatons; they press the buttons anyway, because they have nothing else they can do, and require to be seen to be doing something. If they do not do something, we find there is nobody at all in charge of monetary policy.
On taxes, the sturcture of taxation is not heavily leveraged against the corporate sector. The application of tax effort is rather leveraged against the run-of-the-mill, average person, and the poorer in society; the payer of PAYE, NIC and VAT – 58% of total Government revenues (£530BN out of £915BN: 2012/22 HoC Library). Notably it is the ordinary, inflation hit average and poorer person who therefore pays the largest proprtion of their total incom in tax; not the corporate sector. It is the ordinary person who suffers for this policy catastrophe. Whoever Government is for, it is not being done for you, unless you are part of a very exclusive set.
Thanks
I should say that when referring to ‘proportion of tax’ I mean this in a special way. Neoliberals love to point out that the 1% who pay 29% of all income tax, as if they suffer the biggest penalty; because they have a disproportionate share of income. This means total tax percent paid, or marginal tax rate calculations always makes it look as if the biggest taxpayer is the hardest hit. The biggest tax paid is not the biggest tax penalty. The biggest tax penalty is paid by tax increases paid by those with the least disposable income that is captured by the increase in tax.
Common sense tells us this must be true. The hardest hit by tax rises are those with lowest disposable income. Disposable income alone however looks at income after all tax paid. It seems to me the best way to look at “the hardest hit” is to look at disposable income left, after the base tax-free income is excluded from the figures. I propose ignoring it, because nobody can possibly argue any kind of decent independent life is possible on something around £12k total annual income.
I have not carried out a systematic study, I am hypothesising here; but for someone on say, £20k; after around £12k tax-free and c.£2.5k tax, they would have perhaps circa £5.5k disposable income left. On £50k, probably around £26k disposable income left; on £100k, probably around £54k disposable income left; on £200k, probably around £109k disposable income left. Once you examine the effect of tax increases on someone’s life, with only £5k to make their life manageable beyond what £12k offers; compared even with someone with £25k left; to say nothing of those with far more, I think establishes a more realistic insight into what “the hardest hit” actually means, rather than specious arguments about marginal tax rates (that always seem to rest on the idea tht tax is a kind of robbery) applied to people with signficantly more resources to ride out the storm.
It feels fairly obvious to me the spun supermarket ‘price controls’ are not at all serious. Classic Government b****s. If I was a supermarket CEO I’d be slightly irritated that I was being made the scapegoat for Government failure, but massively happy that, as usual, reform of my sector was not going to happen under a neo-liberal Government….. something that has not been a serious threat since Corbyn got stitched up by the establishment, of which Starmer is a key member.
You are “… suggesting that this is at least plausible.” Looks more than plausible to me. Looks like policy. Interest rate rises will hit renters (commercial and domestic) and mortgage payers much harder than rentiers who will benefit from interest-rate-driven inflation. The “cure” is killing us.
It makes sense to me. Companies and sellers in the economy try to recover costs by raising prices.
On the other hand buyers have to spend more on necessities like food, power and rents/mortgages . They have less money to spend less on other goods and services, e.g. don’t eat out, don’t go on holiday or do up the house.
I am not suggesting it balances out but neither is desirable.
If the government really understood how the economy works , they would have seen the sense is creating money to pay all the public services’ pay claims, almost all of which would have been spent in to the private sector where it was needed. ( c. 35% ? would come back as taxes ) It would have been, not just a fair wage settlement, but a necessary subsidy for parts of the private sector. Maybe with a better input of cash they might not need to raise prices as much?
Once again IMHO the doctrine of ‘the state only has the money it taxes or borrows’ -against a lot of evidence- is hurting the country.
Another public service courtesy of Professor Richard Murphy.
All I can say to those of you on other platforms is distribute this NOW!
Interest rates eh.
Let’s just focus on the word ‘interest’ a bit more shall we and then think of WHOSE interests rate rises are REALLY benefiting?
What a con this all is.
It’s in “our” interest to raise the interest rate! What’s in an “our”?
“At least plausible” seems an appropriately cautious way of putting it. It presumably depends how much of a company’s costs is made up of interest payments – maybe Richard (or another accountant on here) can suggest what proportion is typical. Obviously if it is a small fraction of costs an increase will contribute little more to the total, but for a company where it is a major item it could lead to company costs increasing faster than general inflation.
The variation is high
But the evidence is clear: the larger the company the higher the ratio
So in effect the ongoing increases in interest rates will only encourage larger debt-laden companies to increase prices even more, in particular privatised utilities?
Yes
And regulators will do nothing to prevent this
There is also another mechanism. Interest rate increases normally reduce princes by lowering spending power by increasing mortgages. However many people under 40 do not own houses. They don’t have mortgages. They rent their housing. If landlords are facing higher mortgages then they are going to pass those on to the renters. This is a price increase.
On the interest rate “plausibility” issue, I think you may be onto something. Looking hastily through the BoE’s pandemic influenced report ‘Financial Stability in Focus: The corporate sector and UK financial stability’ (October, 2021) the discussion on vulneribilites is relatively low key (after all, interest rates were on the floor – literally), although the BoE warned of increasing debt levels notably among SMEs through Covid. Then, turning to a very hasty trawl through the Charts file, and my eye alighted on Chart 4, in which the telling, naive insight is in the title:
‘Chart 4: A large increase in borrowing rates would be required to markedly increase the share of business with high debt-servicing costs’.
I leave the thought there …..
Indeed….
The BoE expects us to believe this:
Cost of materials go up – businesses puts prices up
Cost of labour goes up – businesses put prices up
Costs of money goes up – businesses reduce prices
Anyone see anything wrong here??
Yep well argued. Why on Earth make money expensive when there are so many other things a government can do. Clearly we are governed by the Cheats and Clowns Party!
The argument feels persuasive. And as Howard points out above, it’s funny how the data is cherry picked by the neoliberals to support their interpretation of events.
Kelton and Mosler (I know he’s a dirty word around here)* both state that interest rate increases can cause inflation. Are their theories relevant here too? I read something about the interest / income channel but didn’t quite understand it.
* Ed comment: no he isn’t
Richard, Can’t find the actual posting but I think that some time ago you pointed out that since 2010 the top 35 companies in the FTSE 100 had paid out over 200% of the value of their profits to shareholders.
The difference coming from borrowings. Could the impact of financing this reckless borrowing be a major contributor to inflation?
Paul
Apologies for delay: this was it
https://productivityinsightsnetwork.co.uk/app/uploads/2021/06/PIN-Report-29-6-21-FINAL.pdf
Richard
That has been my naive view for some time; sometimes not knowing any formal economics stops the trees getting in the way of seeing the wood. To have expert confirmation consolidates the idea. A lullaby come to mind, but with new words.
We will crush you, crush you, crush you.
We will crush you, crush you, crush you.
We’ll exploit you all we can,
Helpless, Struggling, little man.
I am sure the plan is to release the pressure next year to gain votes in the coming GE. It’s profoundly immoral.
I’m no economist but I do follow your interesting alternative views on the subject.
In terms of interest, how does reducing interest rates fit into your long-held view (at least it feels like that) about using collective interest in our savings to better effect, such as releasing it into the economy to address some of the cost 0f living issues?
Today, I read that Reagonomics (as I see it simplistically as Micauberism) is rearing an ugly head with Biden’s plea to ease the $31.4 trillion (mind-boggling!) in a bipartisan deal with the Republicans? I imagine that the US banks are holding on to a hell of a lot more interest than are our own domestic equivalents.
Please treat me as an interested novice in any reply!
My theories are about saving
I do not think most saving is motivated by anticipation of interest
We save for life events
So I always favour low interest rates and as the period 2009- 2021 proves, that does not stop savings
Yes, I realise your theories are about saving but I must have misunderstood how you wanted to use the interest from savings held in banks for the wider benefit of all, presumably via government intervention.
I’m sorry if I got that second bit wrong, though I did admit to being an interested novice. Thanks for the correction.
The interest on savings is incidental to my plan
It is the capital that matters to me
As a non-economist this makes a lot of sense to me but in light of recent elections in Turkey begs an obvious question.
Is Erdogan right about keeping interest rates down to counter inflation?
It does not seem to be working there – but the scale of the issue is much bigger and he may be right that in that case changing interest rates will make little difference
In the context of this article and the elections in Turkey yesterday, is Erdogan’s policy to lower interest rates to bring down the rate of inflation correct?
As I have previously noted, in the context of the scale of the inflation it may make no difference