Why the Bank of England must raise Bank Rate to 5 per cent without delay

No one can doubt the UK is now in an economic crisis which calls for a prompt and forceful response. I would like to make three points.

1. The UK has history of crises from which we can learn one important lesson. In my lifetime I have observed the following.

Macmillan, 1958: Increased public expenditure to build houses causes inflation to increase. Thorneycroft, Chancellor of the Exchequer, with ministers Enoch Powell and Nigel Birch, resign in opposition to the Prime Minister’s policy.

Wilson, 1964-67: “White heat of technology” accompanied by domestic credit expansion, leading to devaluation of sterling in 1967.

Heath, 1970-4: “Barber boom” follows Chancellor Anthony Barber’s 1972 budget, the money supply explodes, leading to inflation which reaches 27%.

Healey, 1974-76: Fiscal and monetary expansion puts pressure on the pound. The UK is forced to borrow from the IMF.

Lawson, 1987-89: Policy to shadow the Deutsche Mark leads UK to join the ERM. During the Major government in 1992, Bank Rate is raised to 14.88 per cent, but the UK is then forced to leave ERM because of market pressures.

Johnson/Sunak, 2019-22: Covid pandemic forces gigantic monetary and fiscal expansion, but lack of monetary tightening in 2021, with Bank Rate between 0.1% and 0.25% plus excess money creation leads to inflation over 10 per cent.

Also note: Healey raised Bank Rate in 1976 to 15 per cent.

Howe raised Bank Rate in 1979 to 17 per cent.

Bank Rate only fell below 8 per cent for 3 months during Mrs Thatcher’s 10 years as Prime Minister.

The lesson we should learn is that the cause of all these crises is the creation of excess spending by tax cuts for consumers, increased spending by governments and increases in money supply growth. These factors lead to a process of higher inflation, balance of payments deficits, higher interest rates and a falling pound.

2. There are two kinds of economic growth.

The first kind, a short-term dash for growth, can be achieved by cutting taxes to consumers and employees, but is invariably short-term in duration. At present we have a very tight labour market and no excess capacity in the economy. The consequences are rising aggregate demand which is greater than available supply, leading to increased inflation and balance of payments difficulties.

Sustainable growth, the second kind, depends on supply side changes, such as increases in the size of the labour force, increases in the productivity of the labour force and increased investment. Sustainable growth also requires market interest rates, not repressed interest rates such as we have experienced since 2008, as well as cutting inefficient regulations.

Sustainable growth is the laudable objective of present government policy, but its timing without an Office of Budget Responsibility (OBR) analysis of where the UK stands, is little more than cakeism in dreamland.

3. What Should the Bank of England Do?

The Government has given the Bank the worst possible predicament. Without any budgetary framework, it has increased spending, cut taxes and — astonishingly — boasted that this is just the beginning. Excessive fiscal easing must be matched by appropriate monetary tightening. The Bank has been told by the Chancellor, Kwasi Kwarteng, that it is responsible for controlling inflation. The Governor has said there are “no ifs, no buts” if the Bank is to meet its commitment to bringing inflation down to 2 per cent. Now is the opportunity for the Bank to take decisive action and restore credibility.

This requires action by the Bank of England:

1. Bank Rate must be raised to 5%.
2. The Bank must make a commitment that it will not restart Quantitative Easing to fund the increase in public sector borrowing.
3. The Bank should insist that the Treasury ask the OBR for an urgent report on the UK economy.

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