Writing in ConservativeHome on Wednesday 18th May 2022, The Rt Hon Dr Liam Fox MP said:
For many younger people in Britain, inflation is a new and startling experience, something they had previously only heard of in history books. For many of us, it was a formative personal and political force, one of the main reasons why many of us embraced Thatcherite Conservatism and its emphasis on “sound money.” Nothing undermines the stability of our economy, communities, and families more than inflation. It inevitably hits the poorest in society hardest and shifts money away from those who have saved for a rainy day. It is both a moral and economic hazard.
In the 1970s, I remember our family having to make cutbacks (including switching off the central heating we had only recently acquired) as inflation outstripped my father’s income. In the 1980s, I bought my first flat just as the Lawson boom hit. As a junior doctor, I soon found almost my entire income taken up by my mortgage as interest rates surged to 14.88% by the end of 1989.
Today, we are witnessing a return to global inflation, although at widely different levels. It is probably more accurate to say that we are witnessing two types of inflationary surges simultaneously. The first results from the supply disruptions that accompanied the Covid 19 pandemic with a mismatch of supply and demand in commodities and an interruption of global supply chains. The second is what we might describe as the monetary inflation that afflicts those countries whose central banks have allowed persistent increases in the amount of money relative to existing output.
As the pandemic took hold, central banks adopted policies of quantitative easing (QE) but at hugely differing rates. QE results in the purchase of large quantities of assets, such as government bonds, with the aim of supporting economic growth, lowering the cost of borrowing and boosting spending. Designed to have an anti-deflationary effect, too much can result in dangerously high inflation.
According to the Atlantic Council’s Global QE Tracker, in the United States the Fed began purchasing assets during the pandemic at an average rate of $120 billion per month. Since early 2020, these purchases have grown the Fed’s balance sheet by more than 114 percent.
In Britain, the Bank of England (BoE) put in place a QE program of support worth £895 billion to support the UK economy and financial market functioning. The bank’s asset purchases have increased the size of the balance sheet by more than 100 percent since the beginning of the pandemic.
The European Central Bank’s (ECB) pandemic emergency purchase program (PEPP) complements its Asset Purchase Programme (APP). Together, both QE programs have increased the size of the balance sheet by 88 percent since the start of the pandemic.
Meanwhile, in Asia, the Bank of Japan committed $874 billion to support the economy and the functioning of financial markets. These new asset purchases, together with the bank’s increased lending facilities, have increased the size of the balance sheet by a much smaller 17%. The latest inflation figures show the United States at 8.3%, the Eurozone at 7.5%, the UK 7%, and Japan 1.2%.
As the World Bank has noted, “The primary drivers of the inflation spike are not uniform across countries, particularly when comparing AEs and EMDEs. Diagnoses of “overheating,” prevalent in the US discourse, do not apply to many EMDEs, where fiscal and monetary stimulus in response to COVID-19 was limited… Inflation thus has become a global problem – or nearly so, with Asia so far immune.”
So, what about the British experience? Since 1997 the Bank of England has had operational independence for the conduct of monetary policy. The objectives of policy are set by the government while interest-rate decisions are the responsibility of the monetary policy committee. In November 1998, John Vickers, the Executive Director and Chief Economist at the Bank of England, set out the position with great clarity in a speech in Frankfurt.
He said “the paramount statutory duty of the MPC is the maintenance of price stability… The remit recognises that exogenous shocks and disturbances may cause inflation on occasions to deviate from the target, and that ‘attempts to keep inflation at the inflation target in these circumstances may cause undesirable volatility in output’. Most importantly, to me, is that he pointed out that “Subject to the paramount statutory duty of price stability, the MPC must support the Government’s economic policy, including its objectives for growth and employment.”
In other words, while the aims for employment and growth were important and laudable, they were required always to be secondary to the aim of price stability. How has this played out in recent times?
In a speech in November 2020, on the subject of climate change, Andrew Bailey, the Governor of the Bank of England said that: “We decided in the spring to prioritise preserving people’s jobs and livelihoods in this emergency, and as far as possible the businesses that provide employment and the life blood of the economy”. While this is understandable, and in line with the political priorities of the time, it is not putting monetary and price stability at the heart of the bank’s agenda.
In the same speech, the governor also said: “The financial system has supported the real economy in the crisis, as it must. We need that same ambition in our approach to climate change.” While we all support a concerted approach to climate change, there is a distinct feeling that those who should be protecting us from the debasement of our currency, the erosion of our earnings, and the devaluation of our savings have had their minds too much on a political rather than a monetary agenda.
The risk now is that having come late to the inflationary party – and consistently underestimated the nature and scale of the threat despite numerous warnings – the central bankers will overreact. With record amounts of assets on their balance sheets they may move quickly from quantitative easing to quantitative tightening.
While this will reduce the amount of money in the economy and counter inflation, the risk is that they will overcompensate, resulting in recession. This could produce further disruption in the developing economies with potential political disruption and the risk of debt default. This risk is exacerbated by the war in Ukraine and continued supply chain disruption.
No one believes that the policy decisions that need to be taken will be easy, but we deserve central banks who keep their focus on their day job, that of monetary stability.
The Rt Hon Dr Liam Fox MP is former Defence and International Trade Secretary. He was the UK’s Nominee to be Director-General of the World Trade Organization (WTO) in 2020.