LONDON — Yet another bedrock belief about economics has turned out to be false: Printing money — in the form of 0% interest rates — does not always cause runaway inflation.
In any economics class, one of the first lessons students hear is about the Weimar Republic, before World War 2. The German government printed money to pay off its debts, creating spiralling inflation. People ended up pushing wheelbarrows full of cash through the streets in order to pay for a loaf of bread. Money was so worthless that some even burned it to stay warm.
To this day, the German government regards debt and money-creation with deep suspicion.
But central banks in the US and Europe have held rates near zero for years, effectively printing money into the banking system. It turns out you can print money and not see crazy inflation. The most extreme example is Sweden, which has held some interest rates below zero for years. Sweden, in theory, should be well into Zimbabwe territory by now — with people paying for sandwiches with bricks of worthless cash. But inflation there is only 1.7% or 1.9%.
So Bank of England Governor Mark Carney now faces a difficult new dilemma: Should the Monetary Policy Committee raise interest rates to stave off inflation at its next meeting on August 3?
With UK inflation creeping up toward 3%, the “normal” answer would be that the BoE should obviously raise interest in order to stamp out inflation. UK interest rates have been at or near zero for years since the 2008 crash. Central banks have been printing money furiously. The BoE’s target inflation rate is about 2%, and the best way to bring down prices is to reduce the supply of money.
And yet … there is only a 20% chance that the BoE will raise rates in August, according to Pantheon Macroeconomics analyst Samuel Tombs. That’s because the BoE’s money-printing hasn’t actually caused runaway inflation. Sure. it’s going up — but that is mostly an effect of the devaluation of the pound following Brexit.
Here is what’s really going on. This is a chart of wage growth from Pantheon:
In a high-inflation period, you ought to see high wage growth as the economy balloons and workers demand better wages, either through their personal or collective bargaining power, or by flitting from job to job for ever-higher salaries. But wages in Britain are depressed. The jobs/wages situation is so bad it was probably a big factor in the swing toward the Labour Party at the last election. We have close to full employment but no one feels rich. Full employment and growing price inflation have not given British workers extra leverage to demand higher wages.
In that context, increasing interest rates might only damage the economy — by making consumer debt more expensive, and reducing the ability of companies to invest borrowed money into more work. Both those factors might hurt employees and the economy as a whole, pushing the UK into “stagflation” — a stagnant economic period characterised by rising inflation due to the softening pound.
There have been some types of inflation during Britain’s 0% years: House prices have become ridiculous and the stock market is buoyant. The inflation has been funneled into investment assets, not consumer product prices.
But there is something else at work, too.
The powerful deflationary force of technology, the internet, and the gig economy they have created. Consumer price inflation used to hurt workers really quickly. But now, when anyone can search the internet for the cheapest product they need, you can basically import your own price deflation from the cheapest company available. This seems to be what’s happening in Sweden.
Business Insider has previously referred to this as the Spotify effect — the notion that in the past you may have spent £30 a month on CDs but now you spend £12.99 a month on Spotify, and receive vastly more music for the bargain. If your wages remained the same you are now technically £17.01 richer every month. That effect occurs for almost any product that can be bought on the web, and it has created a powerful macro tide.
It’s had a relatively disastrous effect on wages, however.
The rise of software-driven “gig economy” businesses like Uber and Deliveroo have allowed companies to turn their demand for labour on and off like a light switch. Companies can change the number of workers they need by the minute rather than by the week. That has allowed those companies to keep wages down. Because the workers are officially self-employed, it has prevented them from pushing their wages higher.
A fundamental law that was thought to govern the supply and demand for labour is now broken — you can keep wages down in a full-employment economy, it turns out, if your software is nimble enough.
That’s why Carney and the BoE’s next meeting will be so tough. The UK has a small amount of inflation. It’s probably not caused by a runaway economy or a tight labour market. We have weak GDP growth. And raising interest rates may make things worse, rather than better.