Cost of living latest: Bank of England ‘shares some of blame for inflation soaring’ | UK News

Five-minute read: Too much money chasing too few goods – the self-inflicted part of UK inflation problem

By Ian King, Sky News business presenter

It is hard to disagree with Liam Fox’s assessment (see 14.11 post) of why inflation has erupted in a number of the world’s major economies.

As Andrew Bailey, the governor of the Bank of England, noted last week, around four-fifths of the inflation being experienced in the UK economy is down to global factors beyond the Bank’s control, with commodity prices having taken off due to Russia’s attack on Ukraine and shortages of many finished goods having risen as a result of supply chain disruption due to post-pandemic bottlenecks and, of course, the latest COVID lockdowns in China that have caused huge backlogs at that country’s ports.

But part of what has happened has, as Dr Fox notes, been self-inflicted.

Central banks around the world kept up the supply of liquidity to markets during the pandemic with emergency asset purchases, quantitative easing (QE) in the jargon, using the play-book they first adopted in the wake of the global financial crisis and the later Eurozone sovereign debt crisis. This resulted in some quite spectacular expansions in the size of the balance sheets of the US Federal Reserve, the European Central Bank and the Bank of England.

Worrying about the money supply, which was all the rage in the 1980s as the Reagan and Thatcher governments took emergency action to tackle the inflation that had proved so toxic for their economies during the 1970s, has rather drifted out of fashion among economists. That was certainly true among central bankers.

But some economists who came to prominence during that era, such as Tim Congdon, never stopped fretting about figures such as M0, M1, M3 and M4 that measure the amount of money circulating in the economy.

Professor Congdon, who in the days before the Bank of England’s operational independence was one of the so-called “wise men” that advised the former Chancellor Kenneth Clarke, warned early on during the pandemic that the extent to which the money supply was being pumped up around the world was bound to be inflationary.

He told The Daily Telegraph in July 2020: “Central banks are worried about deflation: my worry is that we are heading for double-digit inflation, particularly in the US where the surge in money has been most extreme.

“This is nothing like the period after 2008 when the banking system was crippled and we needed QE just to stop the money supply contracting.”

His warning fell on deaf ears.

This may be partly because, in Japan, the authorities had been using QE in an attempt to stimulate economic activity for the best part of two decades without sparking a surge in inflation. The Fed and other central banks around the world obviously assumed that would be the outcome for their economies, too.

Very little consideration was even given to the money supply, as Professor Congdon noted in an article in the Wall Street Journal in July last year: “Over the past remarkable 15 months or so of highly accommodative policies, the FOMC [the Fed’s rate-setting Open Markets Committee] minutes haven’t once referred to any concept of the quantity of money. “

The high priest of monetarism, the theory that the money supply is the main driver of economic demand, was the Nobel Prize-winning economist Milton Friedman.

Professor Friedman famously described inflation as “too much money chasing too few goods” – and that is a fair assessment of what has been going on.

What is particularly shocking is that, even while discussion of possible interest rate rises was happening, these central banks carried on with QE. The Bank of England did not stop its COVID-era asset purchases until December last year and the Federal Reserve and European Central Bank until March this year.

Ironically, having warned during the pandemic of the dangers of expanding the money supply, some monetarists are now expressing concerns that the money supply is contracting too rapidly – potentially making worse any downturn should the world’s central banks now reverse their asset purchases (quantitative tightening in the jargon) too aggressively.

That is clearly Dr Fox’s diagnosis, too.

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