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ALEX BRUMMER: Covid has awakened the monetary dragon… how far are we prepared to go to slay it?


As the noose of Russia’s domination of the gas market tightens and supply bottlenecks across the globe send producer prices soaring, central banks are finally recognising that the current bout of inflation is more than temporary.

The impact of price rises for basic goods from energy to cotton, from broccoli to timber, will boost pay demands.

The route to a high-wage economy may be faster than Boris Johnson envis- aged with or without greater skills and improved productivity.

More than a decade after the money printing weapon was deployed, there has been little reliable academic study on how it precisely works

Certainly, the technology for a paradigm shift in productivity is there if UK enterprise were to take advantage of Rishi Sunak’s ‘super deduction’, which provides for tax breaks of up to 130 per cent on capital investment. 

Even the old lags in the Road Haulage Association might start to get their heads around some of the AI and logistics technology which has allowed Ocado and Amazon to transform home delivery.

The Bank of England may be right in thinking that once the world adjusts to post-pandemic recovery, producer and consumer prices will stabilise.

In the US, the Federal Reserve is mandated to walk a tightrope between combating inflation and unemployment. 

Chairman Jay Powell has favoured recovery and jobs over inflation. The Bank of England and the European Central Bank, which have less clear jobs goals, have tended to do the same.

The current debate focuses on cost push and inflation expectations.

Western governments sought to tackle this through various forms of prices and incomes policies in the 70s and 80s until monetary policy was seen as the panacea.

The latter part of the 20th century saw the emergence of monetary data as the economic indicator most closely monitored in financial markets, government and central banks. It took over from the balance of payments as the most watched UK statistic.

As the Bank of England, the Fed and others beat back the inflation beast, the eyes of analysts focused on gross domestic product (GDP).

That should not mean that monetary policy is irrelevant. At the start of the pandemic there was an almighty tumult in government debt markets on both sides of the Atlantic. 

In London and Washington, central banks slashed interest rates and embarked on large scale buying of government bonds known as quantitative easing.

The weapon, first deployed in the financial crisis, made sense then because the shock to the banking system was so severe.

In the pandemic it has been much more of a shot in the dark. Remarkably, more than a decade after the money printing weapon was deployed, there has been little reliable academic study on how it precisely works.

What we do know is that it has triggered a monetary and credit creation explosion. The near two years since Covid interventions in the US began saw the broadest measure of money, which includes credit granted by banks, jump by an astounding 35 per cent.

In Britain, monetary expansion has been more moderate. Nevertheless, broad money jumped by around 15 per cent in the year to July.

In its early days, when the Bundesbank influence was still paramount, the European Central Bank was the model for keeping money creation tight. 

As German influence has been eroded and the 27 votes of EU bank governors have carried ever more weight, it too has embraced the credit creation mantra.

One doesn’t have to be a follower of the late Milton Friedman, the high priest of monetarism, to recognise that a historic danger has been unleashed.

Surging credit creation in the late 20th century – before what became known as the great moderation – led to rampant and hard-to-control prices. 

If central banks have not entirely given themselves over to the more populist, political agenda of combating unemployment they might, just might, start to contemplate the monetary problem and asset-price bubble created.

Sure, the supply and demand mismatch in the global economy may have created a price spiral which could be more persistent than at first considered.

More difficult, as policy starts to be tightened, is going to be the decision-making on how far and fast the Fed and Bank of England will need to go if the monetary dragon is to be slain. 

It will be a test of willpower as well as political independence which could see Jay Powell crushed underfoot and Andrew Bailey at the Bank of England under intense pressure.

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