Peter Warburton – March 25, 2021
“If the outlook for inflation weakens, the Committee stands ready to take whatever additional action is necessary to achieve its remit.” Mantras, such as this one from the Bank of England, have become the threadbare apologetics that substitute for a coherent, forward-looking, monetary policy. Imagine a night-time rally driver, deciding to turn off the auxiliary lights because she knows the road so well. Or a solo yachtsman, deciding to dispense with the GPS and follow his instincts. Central banks, casting aside a century-old correlation, are asking us to trust their judgment – and their models – rather than provide sound arguments and analysis to support their decisions.
Lord King, Mervyn to his friends, was no monetarist but he had a healthy respect for the historical association between broad money growth and inflation, which he observed grew stronger, the longer the horizon of change considered. In 2002, when he was deputy governor, he commented that “few empirical regularities in economics are so well documented as the co-movement of (broad) money and inflation.”
The scary part is that the contemporary economics establishment doesn’t believe that inflation is anytime, anywhere a monetary phenomenon. It’s one thing to attach some caveats to Milton Friedman’s famous declaration, and quite another to dismiss it as a total irrelevance. Modern central bankers appear to believe that policy objectives define inflation expectations and that inflation expectations determine inflation outcomes. In their minds, the inflation rate is detached from the economic system, rather like the crime rate. The strength of their resolve to maintain a low inflation rate is the guarantee of success: hence the importance of repeated assertions and restated commitments. For them, inflation, like crime, is a behavioural phenomenon. “Enlightened” monetary policy consists in providing incentives to good behaviour and punishments to bad behaviour.
Pursuing this line of argument to its logical conclusion, it is no more possible to anticipate inflation than street riots, terrorist attacks or a spate of burglaries. The only defence is vigilance. Then, if inflation strikes, the authorities will “take whatever additional action is necessary”. The riot police will be deployed to disperse the angry crowd, with tear gas and water cannons in reserve. There are two problems with this approach to policy. First, even riots have precursors, in the shape of trigger events, social discontent and longstanding injustices. Addressing the underlying issues in a timely and effective manner is preferable to dealing with a riot. Second, in a democratic society, there are limits to the degree of force that the police are permitted to use to quell a riot. Firing live bullets into a crowd is not an option.
In practical terms, the central banks have reduced monetary policy to crisis management. Hiding behind the judgement that there is “a material degree of spare capacity at present”, they assert that a 15%-plus expansion of the broad money supply is no cause for inflationary concern. They are agnostic as regards the consequences of their emergency responses to the pandemic. No doubt they are intellectually curious about the economic impact of their interventions, but they see no justification for a pre-emptive tightening. Central bankers have become so insecure and subservient to the political process that they lack the conviction or resolve to take evasive action that would be likely to have an adverse impact on jobs. “If the outlook for inflation deteriorates, the Committee stands ready to defer effective action until such time as it becomes inevitable.”
Figure 1
Source: Bank of England Quarterly Bulletin Summer 2002