Inflation, Net Zero, and the Bank of England

“What a banker,” read the unsubtle headline in the Sun. “BoE official on £190k salary says Brits must accept they’re worse off.” The Mail agreed. “BoE chief risks fury as he says Brits must accept they are poorer.” What sparked the tabloids’ outrage was a Columbia Law School podcast with Huw Pill, the Bank of England’s chief economist and a member of the Bank’s interest-rate-setting Monetary Policy Committee. Pill made the uncontroversial point that higher energy prices were making Britons worse off, but that attempts by workers and firms to recoup the real spending power they’d lost risked embedding inflation.

Pill had made a similar case in a speech in Geneva earlier this month. For an energy importer like the UK, the rise in natural gas prices represented a substantial deterioration in Britain’s terms of trade, making the average UK resident worse off. Firms and households will seek to pass on those higher costs to their customers and their employers. But at the aggregate level, “attempts to shift the unavoidable cost to someone else are self-defeating,” Pill argued. “All they achieve is to create additional nominal demand pressures that ultimately will create inflation and endanger the achievement of the inflation target.”

Pill’s mistake is not his analysis but his directing these comments to the wrong audience. Attempts by politicians to talk down inflation in the 1970s ended up making those who said them objects of ridicule. “My fellow Americans,” President Ford told Congress in his October 1974 Whip Inflation Now speech, “ten days ago I asked you to get things started by making a list of 10 ways to fight inflation and save energy, to exchange your list with your neighbors, and to send me a copy.” It is rational for economic actors to use their market power to attempt to deflect rising costs onto others. No amount of speechifying will change that. Resulting wage-price spirals are not their fault; the culpability falls on those who misjudged the persistence of inflation pressure. It’s no surprise, therefore, that Pill’s remarks garnered hostile headlines.

Pill’s analysis should have been directed at his fellow central bankers, who let inflation slip the leash. In his Geneva speech, Pill says that central bankers need to assess structural factors likely to prevent inflation falling back to target. “If a rise in energy prices is seen as permanent, it is more likely to trigger greater intrinsic inflation,” he argues. If it does, it would “justify a stronger tightening of monetary policy.” Not mentioned by Pill, however, are the effects of climate policy and net zero on energy costs and prices – and therefore the persistence of inflation on an economy being subjected to a multi-decadal program of decarbonization.

Climate policies drive up energy costs through two channels. The first are policies forcing energy companies to replace hydrocarbons with inefficient, inferior lower-carbon alternatives, notably wind and solar. Were such technologies superior and capable of delivering greater efficiencies, there would be no need for government intervention promoting their adoption. The second channel is by progressively constricting the sources of energy supply, for example by Environmental, Social and Governance (ESG) investors preventing investment in new oil and gas fields, thereby increasing the market share of OPEC plus Russia.

In Britain’s case, powering past coal meant increased dependence on natural gas to keep the lights on. As Pill notes, all market transactions involve distribution of some “economic surplus” between the parties; “the more effective the seller is in extracting that economic surplus, the higher the resulting economic price will be.” Unfortunately for Britain and the rest of Europe, Vladmir Putin and Gazprom have a much better understanding of how energy markets work than Western politicians who made their continent vulnerable to surplus extraction through the myopic pursuit of net zero.

With the Bank of England, it’s not so much myopia as wilful blindness to any possibility of a link between climate policies and inflation. In a speech this month unironically asking “Climate action: a tipping point?,” Sarah Breeden, the bank’s executive director for financial stability and risk, describes its role as creating a regulatory framework that encourages markets “to allocate capital to support real economy decarbonization,” i.e., to worsen the supply constraints on hydrocarbon energy. At the November 2022 G20 meeting in Bali, Deputy Governor Sir Dave Ramsden spoke of the need to avert climate catastrophe. “Among all the shocks – many unprecedented – facing the global economy today, the challenge of climate change is the most profound and far reaching,” Sir Dave declared, in the very month it was announced that consumer price inflation in Britain had reached 11.1 percent. 

From the governor on down, the Bank of England became obsessed with conjuring up specters of climate risk as threats to financial stability, all the while blanking out any possibility that climate change policy might threaten attainment of the bank’s inflation mandate.  Less than two years ago, Andrew Bailey, the bank’s governor, was talking of net zero as a way of regenerating capital and raising productivity. “These positive effects should be larger in countries like the UK that are net importers of energy,” Bailey asserted – the opposite of what the bank’s chief economist is now saying. 

Alarm bells should be ringing in Threadneedle Street. Giving evidence to a House of Lords inquiry on the Bank of England independence, former chancellor George Osborne cast doubt on making climate goals one of the bank’s objectives. His former Labour opponent, Ed Balls, who helped design the arrangements making the bank independent in 1997, went further, arguing that it didn’t make sense to give the bank a role for which it had no tools, and suggesting that climate had become a distraction from its core mission on price and financial stability. Climate is worse than a distraction: misjudgement and misanalysis of climate-change policy is a key factor in the Bank of England losing control of inflation.

Rupert Darwall is a senior fellow of the RealClear Foundation and author of Climate-Risk Disclosure: A Flimsy Pretext for a Green Power Grab.

This article was originally published by RealClearEnergy and made available via RealClearWire.