The Bank of England’s Chief Economist, Huw Pill, has caused another public relations disaster by criticising workers for demanding higher pay – and firms for passing on higher costs. Instead, he told a podcast from Columbia Law School, “someone needs to accept that they’re worse off”.
Let’s begin with a recap of what Pill was trying to say. This is important, because many economists would actually agree with him. Pill was making two points.
First, that the UK economy has been hit by an inflation shock (or more precisely, a ‘terms of trade’ shock) which will inevitably leave us poorer. He was referring here to the jump in the cost of imported energy. Or as he put it, “you don’t need to be much of an economist to realise that if what you’re buying has gone up a lot relative to what you’re selling, you’re going to be worse off”.
This is not particularly controversial. We can debate whether the hit is being fairly shared across the whole economy, but a net importer of energy is bound to suffer more than most during an energy crisis.
Second, he argued that attempts to maintain spending power “by bidding up prices, whether through higher wages or passing energy costs on to customers” would only make the inflation problem worse.
This is simply another way of talking about the risk of wage-price spiral. Higher wages may not have caused the initial jump in inflation, but they could prolong it. There may well be something significant in the fact that wage inflation, services inflation and ‘core’ inflation (excluding food and energy) are all running at around 6%.
So Pill was only making points that other followers of the ‘dismal science’ would recognise. But I still think he was wrong to speak in the way that he did.
For a start, these comments are, as we have seen, highly insensitive – and likely to offend many people. Pill must have known that this would be the reaction, especially after the Bank’s Governor, Andrew Bailey, was slammed for similar comments last year. This adds to the sense that the Bank is asking households and businesses to control inflation, when that’s its job, and that its senior figures are out of touch.
The economics can be challenged too. It is fair enough to point out the risks of a wage-price spiral where higher wages are not justified by higher productivity. But there is little sign that pay settlements are running out of control. A norm of 5% would be consistent with getting underlying inflation back down to 3%, assuming productivity growth of 2%.
The power of wage-price spirals to fuel inflation can be exaggerated too. The overall level of inflation is determined by the balance of demand in the economy and especially by monetary drivers. A wage-price spiral can therefore only be sustained if it is enabled by excessively loose monetary policy. So if the Bank is doing its job properly, wage-price spirals should quickly peter out.
Indeed, if monetary policy were more credible and workers had more confidence that inflation would soon return to target, they might not be asking for big pay rises in the first place.
The Bank also has no business telling individual workers and employers what wages to pay or prices to charge. This should be left to the markets. Indeed, higher wages in some sectors and occupations could actually help to ease labour shortages and the capacity constraints that are contributing to inflation.
Put another way, what Pill describes as a “pass-the-parcel game” is simply the markets doing their job of allocating scarce resources to their best uses, with relative prices adjusting according to supply, demand and cost pressures.
Finally, these calls for wage and price restraint simply won’t work. It seems inconceivable that anyone about to ask for a 6% pay rise is going to have a rethink and say “make that 3%” on the basis of appeals from Bank officials. And no business will be keen to miss the opportunity to pass on higher costs either – if their market can take it, and especially if the alternative is bankruptcy.
In short, Pill might be able to get away with these remarks if talking to an audience of fellow economists. But it is naïve to imagine that they would be received anything other than very badly in the real world.
This piece was first published by CapX on 26 April 2023