This was a good week for those of us who believe that inflation has something to do with too much money chasing too few goods and services. This simple idea is central to the work of the Institute of International Monetary Research (IIMR), based at the University of Buckingham, and to the regular discussions of the Shadow Monetary Policy Committee (SMPC) hosted by the IEA.
Despite this, most commentators pay little attention to the money and credit aggregates. Even the Bank of England prefers to explain its policy of ‘quantitative easing’ (QE) as an ‘asset swap’ that lowers bond yields rather than ‘money printing’. But surely the clue is in the name – QE works, at least partially, by increasing the quantity of money.
The inflation data published last Wednesday is another example of why this matters. The headline measure was widely expected to jump in August due to higher fuel prices. In fact, it fell, which is consistent with the sharp deceleration in the growth of money and credit over the last year.
In turn, this gave the Bank of England the green light to do what it should have done some months ago – hit the pause button on interest rates to assess the full impact of the tight squeeze that is already in place.
Indeed, throughout the cost-of-living crisis, the media have said that inflation has been caused by a surge in food and energy prices, or whatever other prices are rising the most at the time. This is, at best, a description of inflation, not an explanation.
Supply shocks – such as Covid restrictions, the fallout from the Ukraine war, or Brexit – might explain why some prices are rising faster than others. But if these shocks had not happened, the inflationary pressure from excessive monetary growth might have popped up elsewhere.
The upshot is that monetary variables should be discussed more when assessing the outlook for inflation and economic activity. As it is, ‘groupthink’ means that the role of money is repeatedly overlooked, making further forecast errors and policy mistakes much more likely.
