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QE, QExit – inflation and Bank rates.

Inflationary pressures continue and official inflation rates appear to mask the real cost of goods and services to the householder.

General wisdom dictates that this inflation episode is a result of external, imported price pressure – the war in Ukraine predominantly has had a knock-on effect to energy, goods and food prices.

In reality, excess QE, post the need for it, goes some way to explain what we are experiencing now.

Ultra-loose monetary policy coupled with unprecedented level of liquidity provision has created “asset bubbles” as investors chased yield and leverage increased.

In the UK, for example, the BOE’s M4 monetary aggregate, which includes cash in circulation and the bulk of bank deposits, showed that the amount of money rose at an unprecedented annual rate of 10-15 per cent in several quarters of 2020 and 2021.

What do I mean by QE “post the need for it”? the initial round of QE was a legitimate, and needed policy response to calm financial markets as the pandemic took hold in 2019, credit spreads rose and liquidity

The Governor also seems to confuse the ultimate causes of inflation with its symptoms. In his statement, he mentioned the rising energy, goods and food prices. “This is by far the main cause of high inflation, and is painful, particularly for those less well off”, he said. But the rise in inflation – of the general price level – is not explained by the rise in some relative prices. Other things being equal, only when there is an increase in the amount of money broadly defined will there be an increase in inflation. The amount of money in the UK surged in 2020 and continued to grow at extraordinary rates up to the first few months of 2021. When the demand for money started to revert to pre-crisis levels following the lifting of lockdown, we saw a dramatic increase in nominal spending that, coupled up with some supply shortages, led to an inflationary cycle which started to be noticeable during the second half of 2021.

In sum, inflation is principally the result of monetary expansion in 2020 and 2021. Since March 2020, all economies have been affected by the effects of the pandemic and yet it is precisely those economies where the excess in monetary growth has been greater which have seen the most pronounced accelerations of inflation.

For example, in 2020 and 2021 the central banks in Japan and Switzerland did not ease monetary policy dramatically. The annual rate of broad money growth never rose above 8.2 per cent in Japan and only briefly touched 7 per cent in Switzerland, in contrast to the double-digit growth rates seen in the USA, the UK and the Eurozone. Consequently, the rate of inflation has remained quite moderate. Prices rose in Switzerland by only 2.4 per cent in the year to April 2022, while Japanese inflation stood at 2.5 per cent over the same period.

Central banks must understand the effects of monetary growth over the medium and long term if we want to avoid another unnecessary inflationary boom in the future – or a return to boom and bust cycles. The Bank of England must learn this lesson.

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