Why Disregard the Bank of England’s Advice?
This is a question and issue that has been at the back of my mind for the past few weeks. Ever since the announcement of interest rate hikes, tax band changes and inflation expectations- the general media has started to cover and become involved with the macroeconomy. Most recently I heard the voice of Andrew Bailey, Governor of the Bank of England and Chair of the Monetary Policy Committee (MPC), on Sunday night radio- a name even I was unfamiliar with until A level economics. He was giving an interview and was asking the public to remain content with their current pay rates, and not to ask for pay rises, as this would cause wage inflation. He also said without the rise in interest rates to 0.5%, we could expect 7.25% inflation by April. The issue and debate that became apparent to me was the fact that the general public were arguing that products were becoming more unaffordable; they were becoming poorer in real terms and claiming that people would die from the rise in energy prices. Yet, they were arguing that interest rate rises and pushing up taxes would lead them to be worse off. Statistics such as 8.8% of the population experience food poverty are being raised in attempt to justify expansionary monetary policy from the Bank of England (BoE). When in fact, as economists, we know the exact opposite to be true.
And this is exactly the issue that has become even more apparent. Policy pivots, whether it be during recovery or in a boom, lead the public to question why policy changes if times are good. Well, the simple answer is because booms lead to overconfidence, which leads to bubbles and inflation speculation, which then leads to a collapse in investments as it was all speculation. However, as we have seen with the pandemic and financial crisis, as well as Brexit in the UK, other factors come into play- which needn’t be explained.
When in periods of economic recession and hardship, as economists, it is difficult for us to comprehend why people do not respond to act rationally to fiscal and monetary stimuli. The presented answer within our field is behavioural economics. Firstly, the anchoring of the public to the media; claims from exaggerative sources such as the Sun and Daily Mail mean that people attach to the first piece of information offered, such that rising energy prices will cause huge rises in poverty. Yes, this is true, and it is why the govt is offering fiscal warm home discounts to households badly affected. Nevertheless, this effect is short term, which many of the public seem to neglect. In the long run, the rise will self-correct, and become affordable, as inflation becomes controlled and energy companies find more room to lower prices. The rise in prices is necessary for the energy companies, who gain an incentive to leave the market if their methods become less profitable in the long run. However, this anchoring leads the public to neglect this, leading to neglection of BoE advice, and a worsening of the macroeconomic situation. Bounded rationality has the same effect, many people lack a true understanding of what the terms inflation and interest rates truly lead to according to the European Central Bank (ECB). This means that the information they receive, mainly from secondary news sources rather than the govt or BoE pages, is limited and distorted, further distorting public understanding. In addition, the time people have to interpret the information is a factor. The impending pressure and prevalence of social media means that people place an invisible pressure on themselves to be able to discuss these kinds of topics, to enhance intellectuality and status simply. Both of these concepts applied and combined with the lack of altruism in a crisis means that people turn on these institutions and their advice because ‘they got us here in the first place’. People assume that advice and information offered is to manipulate the economic situation in order to provide a collective response, so they decide to deviate to benefit their own utility- when in fact it is the opposite. But people aren’t rational.
The previous paragraph exhibits exactly the barriers towards collective rationality and response. The evidence for this is found when comparing BoE response as opposed to the Federal Reserve (FED) and ECB. The BoE has responded to rampant inflation via interest rates alongside the govt raising the energy price cap and income taxes; whereas the ECB and FED have held back with less drastic measures. As expected, they have received less criticism from the public, but from economists who ravage them for neglecting the long term impact of delayed policy pivots. In addition to harming the countries of residence, this has negative impacts on developing countries who lack the room for policy flexibility and financial resilience. In focus, when you consider this, it seems facetious for UK citizens to complain about policy pivots; as one of the most financially developed countries we have the room for policy flexibility- the welfare state also provides a comfortable cushion for financial resilience. In summary, the lack of contextual understanding of the public leads them to not follow economic advice. If we countermand the behavioural economics; and say that the media is inaccurate and you should educate yourself, you should think about making quick, fast sweeping generalisations and you should think about the effects on others: just like one would about any other social issue such as the response to the BLM movement, it is likely that people will respond better. Additionally, because the MPC is not voted in by the general public, and many of the members are anonymous in the world of the general media, it means that people assume they act in antiquated economic interest, ‘in favour of the rich’. This is also what leads to counter-altruistic behaviour. In addition to this, the defensiveness of the MPC to the success of policies such as quantitative easing means that people are rightfully dubious of entrusting the macroeconomy into their hands.
In conclusion, the way to solve this issue is to control and frame the responses of the MPC as well as the media. This is not suggesting censorship or reintegration of the MPC into the government, but to remind people that monetary policy exists to guide markets, stimulate them - not to control the economy. So in fact, the central bank gives the public and its private sectors control to shape the economy; rather than in Keynesian times when the government guided the macroeconomy through prices and incomes policy for example. In addition, as economists, we know, thoroughly understand and assess both short term and long-term impacts: this is not translated into the public perception of economics. The MPC should adopt a position of liability and responsibility in the intentions of policy as well as the success of policy in achieving objectives as well as the unintended consequences.