The recent  Lords inquiry into Quantitative Easing has led to increased scrutiny of the Bank of England’s extraordinary monetary policies (EMP) and the impacts this is having on wealth inequality and government financing. Yet we argue this focus on solely EMP is too narrow and that it is more important to interrogate the underlying logic of the Bank of England’s monetary policy. Whether extraordinary times or not, we show the Bank has long organised monetary policymaking to discipline labour and protect the interests of capital.

In recent research published in New Political Economy we look at the Bank of England’s monetary policy from 2006-2016 from the perspective of workers and households. From this vantage point we argue that the development of Monetary Policy since the global financial crisis is a continuation of, rather a break from, the pre-crisis approach of disciplining labour through wage restraint and growing household debt.

Inflation Targeting and Wage Discipline

After 5 years of low inflation and regular warnings of deflation it might appear odd to talk about the Bank of England being concerned about spiralling inflation. But this was exactly what was being discussed by BoE policymakers  in 2011 and 2012.

Following two VAT increases, a fall in the value of sterling and rising commodity prices, CPI inflation was persistently high (at over 3%) for 18 months from December 2010, peaking at 4.8% in September 2011. More concerningly for the Bank’s Monetary Policy Committee (MPC), however, was that despite the recent recession wages appeared to be growing consistently and unemployment remained relatively low at 8% (compared to 10% in previous recessions). This risked an inflationary spiral if wages demands were to respond to the higher cost of living.

Figure 1. UK wage growth and inflation, 2006-2016

As a result, despite the relatively weak economic recovery in 2011, some members of the MPC began to advocate increasing interest rates to curb inflation. While this suggestion never became the majority position and there was no increase in the base rate, especially after wages began to fall in late 2012, the narrative from the Bank of England was one of vigilance against wage rises to meet the higher cost of living so that:

if nominal wages start to rise in an attempt to offset that inevitable fall in standards of living, risking a wage-price spiral as the UK had in the seventies, then the MPC would be duty-bound to raise Bank Rate sooner to bring inflation back to target, regardless of any short-run pressures on output.

(Paul Fisher, Executive Director for Markets, June 2011)

The message was clear. The MPC’s core narrative was that labour and households would have to pay the cost of adjustment to higher taxes, commodity prices and exchange rates, rather than capital.

This brief, and ultimately uneventful, episode in the history of the MPC is important because it draws attention to the underlying logic of inflation targeting. While the mandate of the MPC is to hit a price inflation target of 2% CPI, operationally the focus is on wage inflation as the link between changes in the cost of living today and future inflation.

Figure 2. A model of the MPCs approach to inflation targeting

This nominal focus on prices with a practical focus on wages stems from the original design of inflation targeting in 1992 and 1997. Since the 1980s, successive Conservative governments had used restrictive monetary policy, such as monetarism or membership of the European Exchange Rate Mechanism (ERM), in an attempt to enforce wage discipline by creating a tradeoff between wage rises and unemployment due to interest rate increases.

After the UK was forced out of the ERM in 1992 inflation targeting was adopted as a continuation of this strategy. A key part of this process was the focus on a more flexible target of price indices, rather than on relatively rigid targets of  money growth or the exchange rate as under Monetarism and the ERM respectively.

The change in government and operational independence in 1997 simply reinforced the strategy that, in the words of Gordon Brown:

Unacceptably high wage rises will not therefore lead to higher inflation but higher interest rates

(Gordon Brown, 1999 Mais Lecture)

Any monetary policy necessitates distributional trade-offs. This is not only true of recent experiments with extraordinary monetary policy but also the pre-crisis policy of inflation targeting, which allowed  businesses to pass on increased costs to households through price increases, without the fear of reciprocal wage increases (as the MPC ‘looks through’ the price inflation of firms to target the wage inflation of workers).

Asset Price Inflation and Debt Discipline

A second key feature of the inflation targeting regime since 1992 has been the lack of monetary discipline for asset prices. One of the key innovations of inflation targeting was its focus on a narrow basket of wage sensitive goods rather than on broad macroeconomic variables such as money growth or the exchange rate. This focus separated asset price inflation from wage inflation and was crystallised in 2001 when house prices, an investment asset, were removed from the inflation target while rent, a labour cost, remained.

Asset price inflation, deregulation and the rise of securitisation created a market for household debt which incentivised banks to lend in order to distribute the debt of workers and households at a significant margin. This process facilitated an explosion in consumer credit and household debt, which became a cornerstone of economic growth in the UK growth model.

Figure 3. UK household debt as a percentage of disposable income

Inflation targeting can therefore be seen as somewhat of a misnomer: from the Bank of England’s perspective it can be summarised as ‘asset price inflation good, price inflation fine, wage inflation bad’ (to borrow from Jeremy Green and Scott Lavery, and Colin Hay).

This understanding of inflation led to two significant changes for labour. The first was that the profitability of financial firms was increasingly based on their ability to extract debt payments from workers and households. The second was that as rising living standards became increasingly based on the ability to leverage future incomes, workers’ lives became disciplined by the need to make these debt payments.

The global financial crisis in 2007-09 resulted in financial institutions facing significant losses. As financial markets began to reassess the ability of UK debtors to pay their debts, the demand for financial assets fell sharply and lending contracted as banks sought to restore their balance sheets.

In this context, historically low interest rates and the use of asset purchases such as Quantitative Easing are a continuation of the strategy of asset price inflation and debt discipline. Historically low interest rates allowed banks to charge higher margins on their lending to UK households without forcing defaults by increasing the cost of borrowing.

Figure 4. The Bank of England’s base rate of interest compared to consumer credit interest rates.

Meanwhile, asset purchases such as Quantitative Easing aimed to restore the demand for UK debt and drive up the current market value of claims on future debt payments. This allowed financial institutions to ‘scrub clean’ their balance sheets and restore profitability and shielded them from the costs of adjustment to a less exuberant economic future through a return to asset price inflation.

UK households however were subject to an intensified debt discipline. Households are expected and compelled to pay off their debts despite rising costs of living and falling real incomes. At the same time the ability to refinance or ‘revolve’ their debts disappeared as banks required more collateral to lend and their future incomes became less reliable. It was time to ‘pay up’.

Deflation and the limits of labour discipline

The intensification of wage and debt discipline to force the cost of adjustment onto UK households appeared to reach its limits in 2015. Despite a return to real wage growth and the stabilization of household debt levels, inflation remains low as UK households struggle to generate sufficient demand to stimulate economic growth. Household savings as a proportion of  household income have fallen to record lows, indicating that households are now at breaking point as additional income is redirected to meet debt payments and cost of living increments rather than stimulate further demand.

Figure 5. UK household savings as a percentage of disposable income

There is a need then to reassess the long standing strategy of wage discipline and asset price inflation as a central feature of UK monetary policy. For while schemes such as QE may be new in terms of the level of central bank intervention, the disparity in outcomes between the holders of household debt and indebted households is a long standing feature of UK monetary policy.

The current move to seriously critique extraordinary monetary policy and explore alternative approaches is an important step in the right direction, but it does not go far enough. It is time to revisit the central distributional trade-offs and disciplinary nature of the last few decades of UK monetary strategy in order to plot a more equal and prosperous future.