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The Bank of England’s failure to prevent inflation rising in the wake of the pandemic was the result of a collective economic industry amnesia about the role of money supply, according to a former governor.
Lord Mervyn King, who led Britain’s central bank between 2003 and 2013, said on Thursday it was “worrying” that at the start of the price rise in 2020 and 2021 “there were no dissenting voices challenging the view that “Inflation is temporary.” among policymakers on both sides of the Atlantic.
King said in a debate in the House of Lords that the BoE had “tarnished” its balance sheet by keeping interest rates low even as it became apparent that price pressures were increasing.
Inflation rose to a peak of 11.1 percent at the end of 2022, King said, because policymakers ignored the likely impact of a “very significant” monetary and fiscal expansion that boosted demand even as lockdowns constrained supply – a mistake made by other central banks and academics.
“Too much money chasing too few goods is and always has been a recipe for inflation,” he said, calling it “foolish” for central banks to rely on forecasting models that completely ignore the role of money.
“The academic economics profession has essentially jettisoned the idea that one could ask what broad money growth is.” [a measure of the amount of money circulating in the economy] told us,” King said, adding that this consensus “led to the problems with which we are now all too familiar.”
The BoE’s monetary policy committee is expected to keep interest rates at a 16-year high of 5.25 percent next week, although some members have suggested they are willing to vote for a cut as inflation is likely to rise will fall close to its target of 2 percent in the near future.
King, who as governor led the BoE’s response to the 2008-2009 financial crisis and shaped much of its current communications approach, also hit back at Ben Bernanke’s recent criticism of its methods.
He pointed in particular to the former Federal Reserve chairman’s call for the BoE to scrap the “fan charts” it uses to show uncertainty surrounding its forecasts.
“The mistakes of 2020 and 2021 were not the result of the presentation. The Bank might have used fan charts, the Fed might have used dot charts. It made no difference. “They both made the same misjudgment,” King said. “What really counts are judgments about the economic situation and how monetary policy works.”
King’s arguments were echoed by other members of the House of Lords Economic Affairs Committee – including former chancellor Lord Norman Lamont, who first introduced an inflation target for the BoE in 1992, at a time when regimes targeting monetary measures were widely discredited.
BoE Governor Andrew Bailey told the committee this year that the central bank considers money supply as part of its modeling process “and always.” [had] done,” but that “on its own, it is not as good a forecasting tool as some commentators sometimes claim.”
The United Kingdom pursued a policy of monetary control in the 1970s and 1980s, but abandoned this during Nigel Lawson’s chancellorship.
The country subsequently pursued an exchange rate peg-focused policy, culminating in the country’s exit from the exchange rate mechanism in 1992, before the price growth target was adopted.
But Lamont said that even after that framework was introduced, inflation targeting was accompanied by “target ranges for monetary aggregates.”