By Ben Ramanauskas
As the Bank of England tries to wrestle inflation back under the 2 per cent target, Andrew Bailey and the MPC risk driving us into a deeper recession just to save face, writes Ben Ramanauskas
In a move that would not have come as much of a shock to anyone, the Monetary Policy Committee(MPC) of the Bank of England voted to keep interest rates at 5.25 per cent. However, what was surprising is that three of the members of the MPC actually voted to increase interest rates.
The hawkishness of the MPC is in some ways understandable. Its remit is to maintain inflation at 2 per cent and if it doesn’t then it is deemed to have failed at its job.
What is more, the fact that it let inflation shoot up after the pandemic has seriously damaged the Bank’s reputation. As such, policy makers are likely to do whatever it takes to return inflation to target in an attempt to salvage the Bank’s credibility.
Unfortunately, such an approach will cause a great deal of harm to the economy. We’ve already seen the labour market begin to loosen while output in sectors such as manufacturing is down, as are retail sales. Economic growth is also stagnant and is forecast to be so for quite some time.
Money supply is a reliable indicator of which way inflation is heading, and there is every reason to believe inflation will return to target much sooner than the Bank of England believes.
Given that the effects of monetary policy tends to lag behind, we should probably expect these problems to be exacerbated. This will likely mean a recession, job losses, and even more lost years of low growth.
According to the Bank’s forecasts, inflation is not expected to return to target until 2025 and will then drop below target after. The Bank’s forecasts would appear to be too pessimistic. Wage growth – which is the thing which appears to be really concerning the hawks on the MPC – has been slowing. More importantly, money supply growth has all but collapsed.
This important factor has, for some reason, been all but ignored by the MPC. Money supply is a reliable indicator of which way inflation is heading, and there is every reason to believe inflation will return to target much sooner than the Bank of England believes.
Given that inflation is currently well above target it might seem odd to be thinking about this at the moment, but inflation being below target will also be a problem. It will mean that demand in the economy is down; it will only exacerbate the recession we are likely to find ourselves in.
This puts the Bank in a difficult position. As its remit is set by Parliament, Andrew Bailey and the rest of the MPC can’t simply say that they will not try and get inflation down to 2 per cent. While unconventional, Bailey should ask the Chancellor to change its remit so that its inflation target is 3 per cent.
This slightly higher figure would be easier for the Bank to meet without triggering a recession. Initially it will be seen as an awkward moving of the goal posts, but the Bank of England exists to serve the people of the UK, not to boost the egos of policy makers. Asking for a change in its remit is the right thing to do economically.
Ultimately, we should scrap inflation targeting altogether. In its place we should introduce nominal GDP targeting to help policy makers at the Bank ensure inflation remains low and stable while promoting sustainable economic growth. However, tweaking the inflation target to 3 per cent is the right thing to do in the meantime.
The Bank of England’s restrictive monetary policy is doing its job in controlling inflation. However, it’s starting to have a negative impact on the economy. If we want to avoid a recession then the Bank needs to start cutting rates and ask the government to amend its remit.
