The last 24 hours have seen quite a pick-up in the debate over likely levels of infation in the UK. The starting gun was fired by a letter to the Financial Times from Baron King of Lothbury although I note it is described as coming from Mervyn King. Actually the opening is really rather curious.
Price stability is when people stop talking about inflation. It is a long time since inflation was a talking point and memories of an inflationary past are short.
That is because much of 2021 in financial markets has revolved around talk about inflation. Indeed whilst I doubt the word “transitory” is used on the modern equivalent of the Clapham omnibus those who follow financial markets will be aware of its significance. We have inflation building in the world financial system and central bankers are ignoring it because they claim it will fade quickly. The headline case of this comes tomorrow with the US CPI numbers for May. But perhaps such matters do not get discussed at the House of Lords.
Our member of the most noble order of the garter is on much warmer ground here I think.
First, the large monetary and fiscal stimulus injected in the advanced economies is out of all proportion to the magnitude of any plausible gap between aggregate demand and potential supply.
Whilst in many areas we have little idea of potential supply the stimulus has been so large he has a case which is also true about the area below.
The silence of central banks on current high growth rates of broad money has been deafening.
This is a subject to which a blind eye has in general been turned. Actually central bankers will be keen on part of the formal monetarist argument here. That is that the broad money growth flows straight into nominal GDP ( Gross Domestic Product) growth with a lag. They are hoping this will happen much more quickly than the 18/24 month lag of traditional theory. Also their swerve if you will, is assuming it will turn into real growth rather than inflation. The latter is the rub and if history is any guide we will see some and as the push has been large the risk is that the inflationary impact is large too.
The next bit meshes several arguments together.
Second, a combination of political pressure to assist in financing budget deficits, unwise central bank promises not to tighten policy too soon and an expansion of central bank mandates into political areas such as climate change, all threaten to weaken de facto central bank independence leading to a slow response to signs of higher inflation.
It is nice to agree with him for once as the bit suggesting central bank “independence” has effectively morphed into keeping bond yields low is true. The mission creep argument is also true as central banks get out tins of green wash. The Bank of England got out another tin yesterday.
Today we launch an exercise to find out how climate-related risks could affect large UK banks and insurers. Our Climate Biennial Exploratory Scenario investigates the effects of taking climate action early, late or not at all.
Considering the problems they have had with economic models which is supposedly an area of expertise then if I was them I would steer clear of scenarios about which it must know even less.
Our climate scenarios help us to understand the risks UK banks and insurers may face from a hotter world. In our scenario where no additional action is taken, global warming reaches 3.3 °C.
As to the mention of unwise central bank promises our Merv is on weaker ground as he made his own.
Finally we end as we started.
It is when central banks stop talking about inflation that we should be concerned.
The issue is summarised by the use of the word “transitory” again. It is being talked about meaning it is the assumed conclusion that is the problem. It leads us to one of the core central banking problems which is if you dither and delay you will be too late. That leads us to the suspicion that this is an excuse not to act as it feeds the “It’s too late now” line of Sir Humphrey Appleby in Yes Minister.
Proof that central bankers are discussing inflation was provided this morning by the Bank of England’s chief economist.
Bank of England Chief Economist Andy Haldane said on Wednesday there were already “some pretty punchy pressures on prices” and the central bank might need to turn off the tap of its huge monetary stimulus.
“If both pay, and costs are picking up, inflation on the high street isn’t very far behind. And that’s something, you know, people like me are paid to keep a close eye on and we are,” ( Reuters)
He was on LBC Radio and frankly that could have been from a script written by Baron King of Lothbury. As was this.
“And that may mean that at some stage we need to start turning off the tap when it comes to the monetary policy support we have been providing over the period of the COVID crisis.”
Although even he is being rather vague “at some stage” albeit to be fair he did vote to reduce the planned amount of QE bond buying of which there will be another £1.15 billion today.
This bit is really rather confused.
He has previously warned of the risk of a jump in inflation as the economy bounces back from its lockdown crash.
Haldane told LBC that there was still a need to encourage households to spend which might be made easier if companies paid their workers more.
How can you encourage people to spend in a boomlet ( Bloomberg quote him saying the economy is “going gangbusters”) without risking inflation? The inflation risk rises further if he gets the higher wages he wants.
The final punchline according to Reuters was this.
“The risks at the moment for me are that we might overshoot that number for a bit longer than we’ve currently planned,” Haldane said.
There are several issues here and let’s start with our former Governor. He claims there has been no debate when in fact there has been one but that is the issue as it has been one-sided. Also he has two skeletons in his own cupboard. Back in 2010/11 he “looked through” a rise in UK inflation ( both CPI and RPI) went above 5% and even more significantly that led to a decline in real wages we have never really recovered from. Also in spite of claiming he wanted owner-occupied housing costs in the inflation measure it was on his watch ( the switch from RPI to CPI) they were removed and even more significantly have never been replaced after nearly two decades. So news like this from Monday points straight at him.
“House prices reached another record high in May, with the average property adding more than £3,000 (+1.3%) to its
value in the last month alone” ( Halifax)
If we now switch to our “loose cannon on the deck” Andy Haldane there is the issue of wages. These have been struggling in the UK for more than a decade. Recent evidence albeit from the US is that firms have resisted raising wages in response to shortages. Also some workers have found the furlough schemes to be a disincentive. Thus the picture here is both cloudy and complex.
But there is something behind this because the central banks have ignored history and seem determined to continue doing so.