John Rapley is a political economist at the University of Cambridge and managing director of Seaford Macro.
Central bankers must be feeling punch-drunk. For years, they strode like superheroes. We praised their genius, bestowed them with titles such as “maestro” – as one journalist labelled Alan Greenspan in a now-infamous encomium – and revelled in the New Jerusalem to which they’d delivered us: a Promised Land of low inflation and endless credit, where all we had to do to get rich was buy a house and watch it grow.
But then, almost overnight, the story changed. Central bankers turned into villains – architects of soaring inflation, punishing mortgage costs, plunging house values and the inevitable advance toward recession. Unifor chief Lana Payne, leader of Canada’s largest private-sector union, recently charged that, by raising interest rates, Bank of Canada Governor Tiff Macklem “has basically declared class war on working people.”
Ouch. As a long-standing critic of the bank, I partly agree with Ms. Payne. But I’m also experiencing an odd sensation – sympathy for the alleged devil of this drama. Mr. Macklem is doing the right thing in raising interest rates. Actually, the bank should have done it long ago. That it didn’t, ironically, is because it was previously engaged in an actual class war.
It started after the 2008 Great Financial Crisis. During that frenzied time, as asset markets collapsed, the bank cut interest rates to near-zero and turned real rates negative. It justified the action by saying, first, it had to prevent a collapse of the financial system and, second, it wanted to spur an economic recovery. The ultimate effect was that it made the rich richer and the poor poorer.
Just why central banks should feel the need to underwrite asset values is itself an interesting question. Nevertheless, the justification of preventing collapse did at least make sense in the context of the crisis. The justification of spurring recovering, on the other hand, always looked flimsy.
Yes, the economy averted a depression. But the rebound was anemic and relied heavily on rising property values. In theory, cheap credit was meant to spur investment, which would jump-start the economy. But the models on which that theory was based were developed in the 1930s, a time when most investment was carried out by productive businesses. After the 2008 crisis, for various reasons, investment flowed heavily into real estate, an asset which, as I can’t repeat often enough, produces nothing.
Nothing, that is, but a wealth effect. Property owners who felt flush spent a part of their windfall, raising demand. But all the while, owing to that sluggish business investment, the underlying growth of labour productivity kept declining and output rose but slowly. This was bound to eventually boost inflation. Indeed, by the middle years of the last decade, pressures were building.
But the central bank largely waved them off. It said that whatever inflation there was, it wasn’t yet affecting consumer prices, the only inflation which mattered to it. Now think about that. If you’re a young graduate entering a job market where real wages are moribund because productivity growth is so poor, but your rent is rising by double-digits each year, someone telling you that inflation doesn’t matter might seem at best insensitive, at worst hostile. Or even, you might say, a bit like a class warrior. With the bank’s loose monetary policy effectively transferring money from workers to owners, in this case the owners of the houses workers had to buy or rent, it would seem to have been taxing the poor to feed the rich.
In its defence, the bank has put out research showing that income inequality didn’t get all that bad. But that’s not really the point. It was wealth inequality that worsened. Since the Great Crash, the top 10 per cent have seen their share of the country’s wealth rise, with the top 1 per cent doing especially well. Having lost plenty in the crash, they’ve now made back their losses, something for which they can thank the bank. On the other hand, the bottom half’s already-paltry share of the country’s wealth, which briefly started rising during the crash, was knocked back to Earth.
This would explain the one form of income inequality the bank’s research did uncover: that between pensioners and young people. Since the older group derive its income from assets and the younger ones get it from work, it stood to reason that the inflation of asset values would produce unequal distributional effects. Those millennials complaining about boomers were onto something.
Inevitably, though, inflation in asset markets did work its way into consumer prices, forcing the bank to abandon its war to make the world safe for wealth. But while everyone is feeling the pain, it’s actually owners who are taking the biggest hit. Asset prices are falling a good deal harder than wages. That will hurt owners most, including pensioners – not so much the unionized workers.
There is indeed a class war that the Bank of Canada has been waging. But raising interest rates isn’t it.