Expert discusses the potential of economic harm when combating inflation
Key drivers of inflation include fuel prices, business costs being passed on to consumers, transportation costs, used car sales and labour supply. Yet the Bank of England has focused firmly on raising interest rates in its bid to bring inflation closer to its 2% target, much to the frustration of many within the mortgage sector.
As such, Mortgage Introducer reached out to a chief economist to learn more about the possibility of using alternative tools and solutions to lower inflation.
Causing economic harm to combat inflation
Alberto Matellán (pictured), chief economist at MAPFRE Inversión, said interest rates are not the only tool available to the central bank to combat inflation.
“There are at least two other tools, liquidity control and language; in a way, these three are different forms of the same tool, but often both monetary authorities and the public, or investors, focus solely on interest rates, when it should be subordinate to the other two,” Matellán said.
In this sense, Matellán said the language used by the Bank of England does not align with its decisions.
The language of monetary policy, Matellán said, is crucial in establishing agents’ expectations, and a rate hike has a much more pronounced anti-inflation effect when accompanied by an appropriate hawkish message. In such cases, Matellán said economic agents would realise that the central bank is truly committed to fighting inflationary pressures and will lower their expectations accordingly, reducing the need for further rate increases. In this area, Matellán said, the Bank of England may have erred on the side of caution, as its messages have mostly been dovish despite the need for a rapid cycle of rate hikes in response to the evolution of the Consumer Price Index.
However, Matellán said while raising interest rates is a way to reduce available liquidity, there are also other tools that can contribute, such as balance sheet control.
“The challenge in this regard is the direct impact on financial markets - however, like the previous case regarding language, effective management of this tool reduces the need for subsequent rate hikes, and thus [the risk] of causing permanent economic harm,” he said.
Influential factors
Inflation may primarily be a monetary phenomenon, but Matellán said in the current case of the UK, it is influenced by other specific factors.
“Specifically, a large part of its origin lies in supply constraints due, among other things, to Brexit, global shocks in recent years, and the absence of capital expenditure due to energy and financial policies,” he added.
This means that, Matellán said, no matter how hard the central bank tries, the actions it takes are not always the sole solution. Matellán said other economic policy institutions can act on incentives to stimulate supply or shift towards a more restrictive fiscal policy.
“Similarly, the feared second-round effects can occur in the UK due to the characteristics of its labour market,” Matellán said.
The UK, Matellán said, remains one of the tightest labour markets in the world, with an unemployment rate well below the level considered non-inflationary and wages growing at around 7% annually.
“This obliges the Bank of England to continue raising interest rates - but above all, it raises a question; is there a way to ease the labour market without causing a severe recession? Once again, we come back to openness and supply-side policies,” Matellán said.
Long- and short-term solutions
Ultimately, there are alternatives to rate increases, but he said they are only applicable in the long-term and require a high level of political commitment.
In the short-term, Matellán said only the use of more hawkish language can reduce the need for rate hikes. As such, he believes it is unlikely that the Bank of England will refrain from further increases in the near future.
“However, perhaps these increases can be halted before triggering a recession, if language is used in a more aligned manner and supply-side policies demonstrate a serious commitment,” Matellán said.
Do you believe the Bank of England should look to lower inflation in another way beyond increasing the base rate? Let us know in the comment section below.
