The rise in interest rates has shattered the delusion of the lockdown free lunch

It is a moment of truth, with the Bank of England showing it won’t back excessive spending forever

Jeremy Warner for the Telegraph 16 December 2021

At last! The Bank of England has finally done the right thing and raised interest rates, albeit by such a marginal amount that it is frankly quite unlikely to make much of a difference to anyone. Nonetheless, as the first monetary tightening since the pandemic began, it’s quite an event, and perhaps marks that moment of truth when the scales fall from everyone’s eyes and we come collectively to recognise that there is no such thing as a free lunch – that the lockdown strategies of the last two years and the let rip expenditures that have accompanied them have come at a heavy cost, not just to the public purse, but to disposable incomes and living standards in general.

That we cannot carry on like this, effectively closing the economy down every time there is a new wave of Covid, has been obvious for a long time. Yet it would never have been possible in the first place without the support of the Bank of England’s magic money tree. As the pandemic took hold, and hospitalisations surged, Western nations scrambled to follow China’s authoritarian lead of heavy handed restrictions, confident in the knowledge that whatever the price in terms of compensating income support, tax holidays and subsidised business loans, there would always be the central bank to pick up the tab.

Already ultra-low interest rates were slashed close to zero – and further below it in the case of the European Central Bank. As fast as governments would issue the debt needed to pay for lockdowns, the major central banks stood ready and willing to buy it all up.

Modern Monetary Theory – the semi utopian and previously disreputable idea that there is no financial constraint on government spending as long as a country has its own sovereign currency to underwrite it – was tested to destruction. It seemed all of a sudden that governments could indeed spend what they liked and be free of the consequences. You could close an economy down, but carry on paying everyone, supporting shuttered businesses, and generally splashing the cash as if nothing had happened.

To many of us, this always did seem like a state of collective delusion, yet for a while it seemed to work. The main economic argument against lockdown – that it was simply unaffordable – was neatly cauterised.

Yet in providing this service, the Bank of England and its peers in other advanced economies were steadily undermining their own credibility. The Bank’s job is to control inflation. It has singularly failed to do that over the past year, with UK inflation as measured by the Retail Price Index now at over 7 per cent.

Furthermore, it has consistently underestimated the inflationary threat. At every turn, the Bank of England has leant over backwards to accommodate the emergency spending the Government has deemed necessary to support partial closure of the economy. In the jargon, it has fallen victim to “fiscal dominance”, or deliberately prioritising support for government debt servicing costs over its mandate of keeping inflation to the 2 per cent target level.

In ignoring the spike in prices, it has insisted that the pressures are “transitory” and largely – because they are substantially down to external factors such as surging energy prices – beyond the control of monetary policy. This may be partially true, but there is only so long you can hold the line before everyone yells “the emperor has got no clothes”. Both the Bank of England and the US Federal Reserve were perilously close to that moment.

That’s why the financial markets have responded favourably to news of a tightening stance; central bank independence from political pressure to fund government spending priorities was increasingly being called into question, threatening a key certainty in economic planning – price stability. The future becomes much more unpredictable once unable to rely on the central bank to keep inflation under control.

By raising interest rates, the Bank of England has hopefully acted in the nick of time. It may already be too late. As it is, we’ll be paying for the incontinence of lockdown spending for years, possibly decades to come.

Those working in knowledge based sectors of the economy, where skill shortages are particularly acute, may be able to command inflation matching wage increases, but most will see real wages fall, and that’s before the impact of next year’s scheduled tax rises.

The thousands of businesses in hospitality, retail and travel most affected by the latest work from home advice are entirely justified in seeking renewed taxpayer funded support. They are being hung out to dry. Yet it is little wonder that ministers have resorted to scaremongering to force the degree of behavioural change deemed necessary to prevent omicron from overwhelming the NHS.

Never mind the opposition of more than 100 Tory MPs to even the relatively mild restrictions so far imposed, the Government has run out of money and cannot afford another full scale mandatory lockdown. Nor can the Bank of England any longer be relied on to fund one. A moment of truth indeed.

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The rise in interest rates has shattered the delusion of the lockdown free lunch - by Jere
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Andrew Bailey - Governor of the Bank of England

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