The pandemic has left household savings flush, making a surge in inflation likely without tighter controls
It became evident last week that there is quite a disagreement developing in the Bank of England about inflation and the appropriate course of monetary policy. Nothing wrong with that. Indeed, disagreement and debate are healthy.
It is when the establishment all seem to be thinking alike that the greatest dangers lie. Moreover, the disagreement about policy here in the UK mirrors the debate now taking place in the US. The debate has intellectual origins but in both countries the outcome is going to have profound practical consequences.
The world’s central banks are trying to form a judgment on whether the recent slew of price rises, partly related to the effects of the pandemic, is likely to endure or whether it will prove to be temporary. They are right to do this but they are simultaneously wrong in not paying anything like enough attention to something that will have a key bearing on the answer to this question, namely what is happening to the growth of the money supply?
I am having to pinch myself as I write this. For most of my career I have been an arch anti-monetarist. This was not because I believed money doesn’t matter. Still less was it because I was ignorant of the fact that all the world’s great inflations have been accompanied (if not caused) by huge increases in the money supply.
What spiked my opposition to crude monetarism and what I found so irksome about the variant implemented as the centre of the Conservative government’s macro policy in 1979 was the supposed automaticity of the link between changes in the money supply and inflation.
The links between these two things seemed anything but automatic. For a start, it was always possible that changes in the money supply which led to increases in aggregate demand could affect output and employment as well as, or in some cases instead of, the price level.
Moreover, there was plenty of scope for changes in the demand for money (known to a previous generation as the velocity of circulation), with the result that changes in the supply of money didn’t have the predicted effects on aggregate demand. On top of that, there was considerable ambiguity about the precise definition of the money supply that supposedly held the key to movements in prices.
These criticisms of crude monetarism were amply borne out in the early 1980s. Yes, inflation was brought down from absurdly high levels but achieving this required interest rates to be raised to 17pc, and this was accompanied by a collapse in output and employment.
It turned out that the British government’s monetary policy was too tight because it was targeting the wrong measure of money. Once the penny dropped, policy was relaxed and the economy recovered. After a few more attempts to get the “correct” measure of money, monetarism red in tooth and claw was quietly dropped in favour of a looser and more varied attempt to control aggregate demand.
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