Pain, No Gain

Britain​ is entering a crisis in mortgage repayments that nobody can ignore, but which nobody in power seems willing to prevent. In May, the average interest rate for a two-year fixed rate mortgage passed 6 per cent, a reflection of market expectations regarding Bank of England rate rises, which are in turn a response to the sustained difficulty of getting inflation down. Unlike in September last year, when rates spiked in response to Liz Truss’s suicidal ‘mini-budget’, the recent surge in mortgage rates is fuelled less by panic and uncertainty than by a sober assessment of the fix the bank is in. And unlike last autumn, when Rishi Sunak and Jeremy Hunt were parachuted in to rescue the economy from Trussonomics, this time there are no grown-ups to call.

There is always a significant interval between a rate rise and the pain it causes, as fixed-rate repayment deals take time to expire. But 2.4 million homeowners are due to refinance their mortgages before the end of 2023, in a financial climate entirely different from the one in which they signed their current deals (this time two years ago, two-year fixes were available at around 2.5 per cent). The Resolution Foundation estimates that people refinancing in 2024 will need to find an additional £2900 per year on average, but this figure will be a good deal higher in London and the South-East, where property prices far exceed the rest of the country. The Institute for Fiscal Studies calculates that for more than a million mortgage-holders, disposable incomes will fall by a fifth.

Some analysts fear that the repercussions over the next couple of years will be worse than in the early 1990s, when hundreds of thousands of homes were repossessed by lenders. The fact that current rates are lower than they were at that time (and far lower than they were in the early 1980s) is irrelevant: what matters is that households have had to take on far larger debts relative to their income following thirty years of growth in house prices. What might reduce the pain this time is that the proportion of households with a mortgage has been falling, as older people have paid theirs off and younger people are shut out of ownership altogether. Regulations on lenders are tighter than they were thirty years ago, so there is also better protection against repossession.

In the era of central bank independence, which for Britain began in May 1997, the aim of monetary policymaking is to appear as robotic and predictable as possible. The government sets an inflation target of 2 per cent and stands well back, leaving the bank to do whatever the technocrats of the Monetary Policy Committee instruct in pursuit of that target. Whenever a new and germane piece of information emerges, financial markets should in principle know how the bank will interpret and react to it. Central banks try to think in public, publishing copious quantities of economic analysis so that their decisions contain few surprises. This way, interest rate hikes can be anticipated and ‘priced in’ by financial markets, with the hope that this will increase overall confidence in the monetary regime and help to create a climate in which, eventually, rates can be lowered again.

But in accordance with the same principle, when data emerge (as they have) showing persistently high inflation, everyone can be confident that the Bank will keep pushing up interest rates in response, regardless of the social or political consequences. With a general election on the horizon, those political consequences could be profound. The Conservatives may take some comfort in the fact that many of their core voters own property outright (a product of age as much as anything else), but Labour and the Liberal Democrats will no doubt do everything in their power to persuade homeowners in marginal seats that rising mortgage costs are the fault of the Tories, avoiding all nuance concerning their actual causes.

This is the first inflationary crisis that a UK government has faced since responsibility for monetary policy was handed over to unelected technocrats. Britain is entering new political territory. Sunak and Hunt will be plagued by questions about mortgage costs and repossessions between now and the general election, even though they have no power to set interest rates. Meanwhile, the MPC will persist in its sombre, ‘apolitical’ journey towards the 2 per cent inflation target, whether or not the medicine is effective and no matter how devastating its side effects. Sunak must simply pray that inflation falls faster than current projections suggest. Market expectations are that interest rates will peak in early 2024, but that will be too late to help a government which has to call a general election later that year.

While some heterodox economists and a few right-wingers have demanded that the bank change tack, the greater part of the pressure is being put on politicians to act, using the main lever available to them: fiscal policy. So far, Sunak has resisted requests for government to offer financial help to distressed mortgage-holders. But it seems doubtful he will be able to resist all the way up to the election. The same Resolution Foundation paper estimates that, by 2026, total mortgage payments will be £15.8 billion a year higher than they were in December 2021. Ed Davey, leader of the Liberal Democrats, has already demanded a £3 billion mortgage protection fund, to help people whose homes might be repossessed. Keir Starmer is unlikely to say anything that smacks of fiscal flexibility, but will seek to make as much political hay from the crisis as possible.

Homeowners are a powerful political constituency, both symbolically and psephologically, in a way that renters – to make the glaring comparison – are not. After all, rents too have been soaring since interest rates began to climb at the end of 2021, especially in London (increases in Newham and Greenwich in the year to April averaged more than 18 per cent), but few lobby journalists would waste a question to the prime minister on that topic. If Sunak were to cave, and offer some kind of help to those who can’t meet their mortgage payments, it would be a reflection of the cultural and generational priorities that dominate Westminster. It would also be the latest in a series of interventions signalling the newly ambiguous authority of markets in the UK and elsewhere.

From one perspective, the imminent trouble over mortgage repayments is the result of sound economics and sensible governance. According to macroeconomic orthodoxy, inflation in the UK may have been triggered by the war in Ukraine and global supply-chain problems following Covid, but it has kept rising because of strong wage growth. Workers’ demands that pay keep up with inflation (a demand that has not been met, but never mind) are responsible for a ‘wage-price spiral’, where prices then rise to pay wages, and so on. The way to bring inflation under control, on this view, is to increase interest rates so that firms borrow less, the risk of unemployment rises and wage demands fall. The squeeze on disposable incomes will reduce economic demand, and price rises will cool. If it takes a recession to achieve all this, then so be it. Andrew Bailey, governor of the Bank of England, has refused to state things quite so bluntly (as Karen Ward of JPMorgan Chase, a member of Hunt’s economic advisory council, did recently when she told the BBC’s Today programme that the bank’s decision-makers ‘have to … create a recession. They have to create uncertainty and frailty’), but concern for households, workers or businesses is simply not part of his job description.

Conservative critics go further, arguing that the bank brought this crisis on itself. They say there has been an excessive loosening of monetary policy over many years, accompanied by the ‘unconventional’ monetary policy of quantitative easing (initiated in 2009, and ramped up during the pandemic), which effectively creates money from nothing and pumps it into the financial system in order to drive inflation up. From the hardliner’s perspective, all this is evidence that the bank was too concerned with economic growth and prosperity when it should have remained focused on inflation (even when there was none). The ‘conservative central banker’ knows that the best way to fight inflation is to show no interest in human welfare, such that financial markets will trust you mean business. Swept up in the sentimentality of the post-pandemic recovery, the argument continues, the MPC was too slow to react when inflationary warning signs started flashing in summer 2021, and is now ‘behind the curve’.

Bailey has been doing a better impression of a ‘conservative central banker’ of late. The most recent rate hike, an unexpected half-point rise to 5 per cent, was a show of bravado that the bank would ‘do what was necessary’, as Bailey put it. Britain needed to learn that it cannot sustain ‘the current level of wage increases’ (the Office for National Statistics reports that average pay fell by 2 per cent in real terms in the year to April). These are the noises that Bailey’s most important audience – the City and the financial press – wants to hear. On the topic of rising mortgage rates, the Financial Times has stuck to the neoliberal mantra that a degree of pain is necessary to flush out inflation, and that the government should leave the Bank of England to get on with this unhappy task. ‘Handing out public money impedes that harsh but necessary process,’ the FT editorial board recently declared. ‘Ultimately the best way to support mortgage holders is for the BoE to get inflation back down.’ Only once people have suffered will equilibrium be restored.

This analysis represents simple common sense in the financial sector. But as an argument aimed at winning over large constituencies in the public, Parliament and the media, it seems completely spent. ‘Nearly everyone in European politics, from right to left, now accepts that governments must play a big role in the economy,’ the Economist admitted last month. Sunak, with his Stanford MBA and tender years spent at Goldman Sachs, may not be happy about this, but he does accept it. Demands for government assistance are no longer the exception but the norm. The strain between economic forces and social expectations – not to say basic social needs – has grown so unmanageable that government is now caught up in a rolling debate as to where the next handout, bailout or subsidy will be needed. While power may still rest with ‘the markets’ and technocratic bodies such as the Bank of England, responsibility is put at the door of politicians.

Nobody​ conceived or designed this new state of affairs in the way that the Chicago School of economics and conservative think tanks are often credited with cooking up the policy programme of Thatcherism. But a pattern has emerged nevertheless. At its core is a belief that market prices are no longer the final word. Ed Miliband was on to something in 2013 when he committed Labour to freezing energy prices. The Scottish Parliament was ahead of its time when in 2012 it legislated for minimum alcohol pricing. It was the protracted economic emergency of the pandemic that forced the government into offering financial help where it seemed most urgently needed, with precious little time to plan. And it’s the inflation crisis that has sustained the expectation that governments will step in to aid and protect key constituencies. It is often forgotten that, amid so many other extraordinary policies, Truss was committed to freezing all household energy bills for two years, at a cost of £150 billion to the taxpayer – only slightly less than the annual budget of NHS England. Climate change and the freak weather events it entails will only intensify the demand.

The crisis of the 1970s was experienced as a succession of government planning failures – proof, apparently, that governments could not exert sufficient control over events to implement their fiscal programmes effectively. There were too many unknowns (wars, social upheavals, new technologies) and too many unintended consequences (conservatives claimed, for example, that the welfare state inadvertently led to family breakdown) for centralised planning to work. The advantage of markets wasn’t that they brought the future under control, but that they were capable of reacting to uncertainty and representing it in the form of prices and risk calculations. Efforts by governments to control prices, including wages, were judged to have failed. As the sociologist Greta Krippner describes in Capitalising on Crisis: The Political Origins of the Rise of Finance (2012), American policymakers never actively sought a world of liberated financial markets or an economy dominated by finance. Handing decisions over to markets and technocrats was a useful way for politicians to distance themselves from choices that had become too hot for them to handle.

There are several echoes of the 1970s today, in the form of inflation, economic stagnation, heightened industrial action and an energy price shock. But few in 2023 are demanding less government intervention and more markets. On the contrary, dramatic price movements are met with the demand that governments do something to protect national populations from the impact of international shocks. Efforts to depoliticise the economy, to distance ‘politics’ from ‘economics’, no longer seem to work. The economist Isabella Weber was met with scorn from many in the profession when she argued in the Guardian in December 2021 that strategic price controls would be a better response to the current situation than monetary tightening (‘truly stupid’, Paul Krugman called her position on Twitter, before deleting the tweet and apologising). Weber’s argument, supported since with empirical analysis, was that profits were responsible for rising prices, not wages. In politically sensitive areas such as energy, her view has become the new common sense. The IMF has accepted that rising profits have made a larger contribution to inflation in the Eurozone over the past two years than wages, and that ‘companies may have to accept a smaller profit share’ if inflation is to fall.

When market forces are being overridden, which logic should be deployed instead? How else will goods be priced and credit allocated, if not on the basis of cold market rationality? This is the question, according to Krippner, that policymakers grew weary of answering in the 1970s. The trump card of economists and neoliberals has long been that, even if markets generate socially undesirable results (such as home repossessions), they do at least make clear how resources should be allocated – an algorithm for which we have no realistic alternative. But there has always been one important consideration, which has occasionally overruled the market: national security. It is to this that many are now turning in their efforts to define a ‘post-neoliberal’ consensus. In April, both Janet Yellen, the US Treasury secretary, and Jake Sullivan, the US national security adviser, made speeches in which they set out the terms of a new economic policy agenda, according to which government would exercise greater discretion – and willingness to intervene – in international markets. The US had been duped, Sullivan argued, into thinking that markets always allocate goods and services efficiently and that growth is always good, regardless of how and where in the world it is generated. In the future, Yellen said, policymakers would need to ensure that the US could produce more of its own goods, making it less reliant on states, such as China, that do not share its ‘values’. Reversing several decades of supply-chain offshoring, the US would pursue both onshoring and ‘friendshoring’, in which goods are produced in partnership only with strategic allies.

Yellen and Sullivan were giving an ideological (and somewhat nationalistic) rationale for a series of legislative and fiscal measures that the Biden administration had already introduced. The CHIPS Act, passed last summer, allocated $280 billion of federal investment to boost semiconductor research and production within the US, thereby reducing its dependence on China. The Inflation Reduction Act (IRA) will make an additional $500 billion available, the majority of which will support clean domestic energy production. Such measures can be justified by reference to the climate crisis, but reducing reliance on potentially hostile trading partners is politically more salient (China produces most of the world’s wind turbines, for example).

Europe has been paying close attention to these developments, not least because industrial policy on this scale is ultimately a threat to its own competitive advantages. In April, the European Union relaxed its cherished state aid rules, which limit the capacity of member states to disrupt market forces with subsidies, permitting states to invest in ‘sectors strategic for the transition towards a net-zero economy’. Rachel Reeves, the shadow chancellor, has jumped on the bandwagon, giving a speech in Washington DC in May outlining her vision of ‘securonomics’, in which a more interventionist state would pursue prosperity alongside security. Labour had already promised to invest £28 billion a year in green industries, though Reeves has since backtracked on this, stating instead that investment would gradually rise to that level.

The sudden vogue for industrial policy has drawn criticism from some on the left, suspicious of public money being channelled towards ‘national security’ and the green transition in the form of tax credits and subsidies – a policy aimed at getting large asset managers on board. What’s envisaged is really a new wave of public-private partnerships, albeit on a far larger scale than the Private Finance Initiative that successive Tory and Labour governments concocted in the 1990s (initially as a public accounting fiddle), and with a far greater sense of urgency. Political economists including Daniela Gabor and Brett Christophers have questioned whether this project of ‘de-risking’ green investment, by pumping vast public subsidies into privately owned ventures, is really ‘post-neoliberal’ at all. Fund managers are being offered a huge fiscal carrot, and risking a very little regulatory stick.

Be that as it may, these funds contain trillions of dollars, and some way of influencing their decision-making seems like a global necessity. One of the difficulties of industrial policymaking today is that most states lack the expertise to make and manage investments on this scale, relying on the private sector to make things happen, as demonstrated by the (frequently scandalous) outsourcing during the pandemic. The state can no longer go it alone, if it ever could. Reeves justified her climbdown from the £28 billion pledge partly on the basis that a prospective Labour government wouldn’t have the capacity to invest such amounts from day one. For the moment, the dominance of financial actors and markets in the economy is viewed as regrettable but incontestable. If government is to do more to secure and protect the nation – geopolitically, ecologically or socially – it will have to be in spite of, or in partnership with, financial institutions.

In a geopolitical context, measures such as the CHIPS Act and IRA, and statements like those from Yellen and Sullivan, are responses to the current moment: tensions with China, Covid-19 and the invasion of Ukraine have brought the happy delusions of globalisation to a shuddering halt. But there are plenty of domestic reasons the economy has grown more politicised in recent years, and the autonomy of markets is now viewed with much greater suspicion across the political spectrum. The classic Thatcherite pitch, resuscitated by George Osborne in 2010 and by elements in the financial commentariat today, is that resetting the market is painful but worthwhile. If we don’t take the medicine now, we’ll need even more of it and worse tomorrow. Just think how good we’ll feel when it’s over. Ronald Reagan’s campaign slogan in 1984, ‘It’s morning again in America,’ spoke to a sense that the brutal recession of the early 1980s had been for the best, and a new dawn had broken.

Is this logic expected to work in Britain in 2023? What sunlit uplands are supposedly waiting for us, once the period of stagflation and repossessions is over? In the absence of an increase in productivity, there’s little scope for wages to make up the ground they have lost in recent years. Real-term wages in Britain today are no higher than they were in 2005. Since the global financial crisis of 2008, a succession of mostly Conservative politicians has sought to assure the British people that once the difficult bit (first austerity, then Brexit, then Covid) is behind us, the good times will roll. But the difficult bit never seems to be over. So why listen to Andrew Bailey or Jeremy Hunt, when they tell you this foul medicine is for your own good? Any lingering faith in progress has been replaced by a sense of déjà vu. Despite evidence showing that only the top 10 per cent of earners received above-inflation pay rises last year, Sunak has threatened to squeeze public sector wages further in an effort to combat inflation. This is the talk of a technocrat who learned economics from outdated textbooks, not a man fighting for his political life.

What’s more, the constituencies that are suffering now are too politically awkward to be brushed aside with patronising talk of market forces. The recession of the early 1980s pummelled manufacturing and jobs; austerity in the 2010s punished benefit claimants, undergraduates and local government. All of these could be treated as human and electoral collateral by the Conservative governments and media cheerleaders of the day. Homeowners are a far more awkward proposition – hence the panic on the Tory backbenches. The industrial conflicts of the 1970s and early 1980s were led by the miners, viewed by free marketeers as dinosaurs living on borrowed time. Today, despite the media’s focus on rail strikes and the RMT, the most radicalised workers in Britain are doctors. What technology or overseas supplier is expected to replace them? London, once the oversized heart of this ‘aspiration nation’, is slowly emptying out of young people and children, as the most basic expectations – of home, family and money for a holiday – become all but impossible to meet. The gap between housing costs and wages has rendered the British economic model socially unsustainable, not just on the cultural or geographical margins, long brutalised by conservative politicians, but at its very core.

This ought to provoke a reckoning that extends far beyond another bailout or tax-relief scheme – to mortgage-holders or anyone else. The frequency of such interventions is adequate proof that the official ideology of the Bank of England and the financial media doesn’t work any longer (if it ever did). ‘Securonomics’, and what Yellen calls ‘modern supply-side economics’ (where the aim is to increase overall productive capacity, rather than just leave it all to markets), offer the vague contours of a different kind of economic future, in which we get richer and safer – once governments master the art of industrial investment, that is, and productivity gains feed slowly into wages. But even at its most ambitious, this emerging paradigm scarcely pretends to replace the status quo, merely to supplement it with a more active state. In the meantime, people must go on making sacrifices for an economy that offers them nothing in return.