Lord Flight is Chairman of Flight & Partners Recovery Fund, and is a former Shadow Chief Secretary to the Treasury.
The Bank of England and Treasury were correct to adopt Keynesian stimulant measures when the Covid bombshell hit. The economy was kept afloat, where otherwise there would likely have been an economic collapse.
As Andy Haldane has argued, it is now pretty clear that the time has come to start to phase out these stimulatory measures, as not to do so poses a dangerous risk of rising inflation that could force the Bank of England to execute an economic ‘handbrake turn’ in sharply reigning in the loose monetary policy.
It is, however, always difficult ‘getting off the opium’. The danger is that the Bank goes on expanding money supply/QE, with negative interest rates and rising inflation. It certainly looks as if Haldane has got it right and Andrew Bailey and the Bank of England have it wrong.
It is now time to start tightening monetary conditions (albeit not aggressively) and scaling back the emergency stimulus so as to keep inflation under control.
It looks as if the Monetary Policy Committee (MPC) is gearing up to scale back the emergency stimulus. The House of Lords Economic Affairs Committee Report – “Quantitve easing – a dangerous addiction” – has had significant impact on the MPC and the market. It is reasonable for the Bank not to want to see the economy retracting, but inflation is the result of too much money chasing too few goods, which looks as if this is where we are.
The Bank of England argues that the current nudging up of interest rates towards three per cent expected next year is caused by transient factors, especially the global increase in oil prices – albeit that rises in oil prices have been a major cause of inflation over several cycles of the last 30 years. The Bank of England Report made no mention of the recent surge in UK monetary growth. CPI inflation has already jumped to 2.5 per cent in June and will rise further in the coming months; and prices are now going up e.g. the review of railway charges.
The Bank of England Report made no mention of the recent surge in monetary growth or of the measures of money supply conditions in the MPC policy statement. The MPC is still planning more stimuli by completing the purchase of the £150bn of gilts under QE policy.
Economic recovery and the pickup in inflation have been stronger than the MPC or the Bank of England expected. With conditions having changed, policy should also change, and it is apparent that injecting more stimulus now may be unwise. It is time to end QE next month and to scale back gilt purchases. A managed and relatively modest tightening should not derail economic recovery. In fact, it should deliver a more sustainable recovery. As Haldane has made so clear, now is the time for a gentle change of direction.
The Bank’s response has been that it has been important not to overreact; the British economy is not yet fully recovered and the jump in prices has been caused by bottlenecks and Covid distortions; which are not permanent.
Bailey has made it very clear that he does not want the Bank to react to what he identifies as temporary strong growth and inflation, in order to ensure the recovery is not undermined by premature tightening. He expects the rise in inflation to over three per cent next year to be temporary. But it is not good enough to hope that inflation will return to two per cent in two years, if it hits five per cent first. The fact is that the economic recovery and the pickup in inflation have both been stronger than the MPC expected when it made the decision to expand QE last year.
Bailey expects the rise in inflation to be temporary and claims his reasons are strong and well founded. Haldane believes the economy has already regained its pre-Covid size and so is increasingly at risk of overheating.
The danger is that inflation rises to over three per cent later this year, where Bailey’s claims that this is only temporary and that the Bank should not react by tightening, cutting back QE, or raising interest rates and that it should keep stimulating the economy are likely to be met with widespread scepticism in the markets. His recent “good news” was that the economy is only some five per cent smaller than it was 18 months ago, and that the gap is closing quite rapidly. If so, it is a good reason to phase out the expansionary measures.
My money is on Haldane and starting gentle tightening now. With the extent of gilt interest rate servicing required, it will be crucial to keep interest rates as low as possible.