For the first time in a very long time, central bankers are coming under friendly fire as they lose control over some of the economic forces they themselves have helped to generate.
The UK economy, even by today’s general standards, is in a world of pain. This is due to a slew of reasons, from the fallout of unfinished Brexit to the ongoing impact of pandemic-induced lockdowns to the war in Ukraine and the West’s backfiring sanctions against Russia. The latest data suggest that UK growth will turn negative this quarter while inflation, already at a 40-year high of 9%, is expected to break into double figures some time soon. The high street is dying a long, slow death while manufacturing is still 2.2% smaller than it was pre-pandemic.
Bank of England “Wrong Again”
The Bank of England has warned of a looming high-inflation recession, otherwise known as “stagflation,” which threatens to push millions of families deeper into poverty and tip many cash-starved businesses into bankruptcy. The bank’s Governor Andrew Bailey recently warned of a “very real income shock” due to soaring energy prices and “apocalyptic” food prices. As the desperation grows, people are understandably looking for someone to blame. Some are pointing their finger at the Bank of England itself. In an article on Monday, the Daily Telegraph wondered how the BoE could have got it “wrong, again”, on Britain’s slide towards recession:
The bank had thought the economy would still be growing, albeit weakly. In its downgraded forecasts last month, officials predicted the UK would eke out growth of 0.1% this quarter, with a contraction only taking hold at the end of this year after October’s expected 40% rise in the household energy price cap.
Instead, analysts now think GDP will fall this quarter by between 0.5% and 0.7%. It marks a significant shift in expectations over a very short space of time.
This is not the first time the Telegraph has shone a light of the BoE’s recent failings. On May 28, Tim Wallace lambasted Andrew Bailey and the BoE for failing to heed warnings over runaway inflation. Some of those warnings had been raised internally within the bank but went unheeded:
By February 2021, the Bank’s forecasts showed the tiniest bit of inflation and predicted it would stand at 2% today.
Andy Haldane. then the Bank’s chief economist, flagged that risk prices might not behave, calling inflation “a tiger… stirred by the extraordinary events and policy actions of the past 12 months.”…
In May 2021, Haldane voted to end QE early. Looking back, he says risks to inflation were “balanced fairly and squarely to the upside,” with demand unleashed into a world of limited supply. “The laws of economic gravity had not been suspended.”
But Haldane was outvoted. “It would have been nice if I could have convinced [the] eight others around the table.”
Haldane’s was a lone voice that was drowned out by the prevailing consensus that inflation was only transitory. Once Haldane left the BoE to become chief executive of the Royal Society of Arts in June 2021, only two other BoE members ever voted to curtail QE, notes The Telegraph. A month later, the House of Lords’ Economic Affairs Committee, whose members include former BoE governor Lord Melvin King, was calling QE “a dangerous addiction” and asking the Bank to explain “why it believes higher inflation will be a short-term phenomenon.”
The Bank of England is not the only central bank being brought to task for losing control over the economy. In an article published last week in Project Syndicate, the economists Willem H Buiter and Anne C. Sibert warn that major central banks “have lost the plot when it comes to fulfilling their price-stability mandates.” Both the Federal Reserve and the Bank of England have done too little, too late to bring inflation under control, the authors argue.
“Be Happy” for Inflation
It’s worth bearing in mind that central banks have been trying their damnedest since the Global Financial Crisis to create enough inflation in order to gradually inflate away the debt, but perhaps not on the scale we are seeing today. A perfect reminder of this now somewhat inconvenient fact is an article by Reuters’ chief correspondent Balazs Koranyi from October 2021, which insisted that the return of inflation is a victory, not a defeat, for central banks.
Yes, inflation is back, and you should probably be relieved if not outright happy.
That is the verdict of the world’s top central banks, who hope they have hit the sweetspot where healthy economies see prices gently rising – but not spiralling out of control.
Backed by vast government spending, central bankers unleashed unprecedented monetary firepower in recent years to get this result. Indeed, anything less would suggest the biggest experiment in central banking in the modern era had failed.
Only Japan, which has been trying and failing to heat up prices since the 1990s, remains in the inflation doldrums.
For the other advanced economies, a rise in price pressures puts the elusive goal of unwinding ultra-easy policy within sight and at last raises the prospect that central banks – thrust into prominence during the global financial crisis – could finally step back.
The current inflation rise is not without risk, of course, but comparisons with 1970s style stagflation – a period of high inflation and unemployment combined with little to no growth – appear unfounded.
Of course, back then inflation was “just” 4.2% in the UK, 6.2% in the US and 4.1% in the EU (compared to 9%, 8.5% and 8.1% respectively in May). Now, fears are rising that central banks will not be able to tame the inflationary forces they have partly unleashed, at least not without causing huge economic pain, dislocation and destruction in the process…
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Nick Corbishley 