Sir Julian Brazier is a former Defence Minister, and was MP for Canterbury from 1987-2017.
Opinion is sharply divided between those who feel that the Bank of England has gone far enough on interest rate rises and those who believe that more needs to be done to slay the inflationary dragon. Interest rates, the principal monetary lever, are of course controlled by the Bank of England, which holds the statutory responsibility of keeping inflation close to its government-set target (currently 2 per cent).
Many Conservative commentators belong to the second school. For example, Ross Clark of The Spectator tells us that we are facing a wage-price spiral. Several of his colleagues have started describing certain price rises as ‘sticky’ in the magazine’s (otherwise brilliant) podcasts.
The old joke about economics being invented to make astrology respectable seems to be coming back into vogue. It is a generation since Margaret Thatcher abandoned all this Neo-Keynesian thinking, set her face firmly against prices and income policies, and made it clear that the key to tackling inflation was curbing the growth in money – or rather the gap between the growth in the money stock and the growth in the economy – too much money chasing too few goods.
This view has been broadly understood since the ancients and was developed in the 18th and 19th century, but its principal modern apostle Milton Friedman was critical to the former Prime Minister’s thinking. Let’s see what the money supply figures have to tell us both here and in America, whose economic cycle we so often follow.
During Covid, both the Bank of England and the Federal Reserve (“the Fed) printed money in industrial quantities, although the latter went much further with M2 growth peaking at nearly 27 per cent in January 2021, while our own M4 growth peaked at just below 14 per cent in March 2021. Not surprisingly, inflation took off in both countries and Neo-Keynesians belatedly joined the monetarists who had been warning for some time that action on interest rates (that is monetary action) was urgently needed.
Restoring interest rates to sensible levels followed. The question we started with – whether to continue or ease off – sharply divides those two schools of thought once again.
Neo-Keynesians believe in expectations driving inflation so pay rises, whether private or public, are inflationary. They see wage growth as increasing the persistence of inflation. Clearly, public sector pay policy is critical to fiscal policy, which underpins monetary policy, but monetarists reject any attempt to control private sector wages as pointless.
Instead, Margaret Thatcher, Geoffrey Howe, and Nigel Lawson focused on monetary growth. Today this has shriveled in the UK to 0.1 per cent per annum and has been below 2.5 per cent ince January. Across the Atlantic, M2 has been negative since January and in May shrank at its fastest rate since the 1930s. There are two further important factors – the additional time lag on mortgages and the measurement of inflation itself.
The transfer of most holders of mortgages, over the past generation, from variable to medium-term fixed rates has introduced a second-time lag into monetary policy. On top of the typical 18-month interval between monetary growth and inflation, painstakingly charted by Friedman, there is now an additional delay between interest rate movements and changes in the money supply itself.
The second key factor is how we measure inflation. The internationally recognised measure of the rate at which money loses (or gains) value is the GDP deflator, which looks across the economy as a whole. It is this overall measure which responds to monetary factors – rather than individual prices which may fluctuate heavily within it.
Unfortunately, measuring the GDP deflator is a long, slow business so it is published months behind and then subject to frequent substantial revision so – like other countries – we give our central bank a target based on a subset. In Britain and America, we have chosen to focus on consumer prices which often move collectively heavily out of line with other important parts of the economy like house prices, as has been the case both during Covid and over the past 6-9 months.
So, absent an up-to-date and reliable measure of the whole GDP deflator, to get a rounded view of where we are, we need to broaden the current narrow of prices at least to include house prices. As house prices are actually falling (here and in America) this would show general inflation to be substantially lower than the Bank is measuring it, in comparing it with its target.
A further twist to the current debate is that neo-Keynesian commentators, including those in the Bank, have now dreamed up a new even narrower measure – so-called ‘core inflation’ which excludes fuel and energy. No rigorous study has been advanced to suggest why this small, unrepresentative, group of price movements is representative of the whole (economists just observe that it fluctuates less quickly than food or fuel prices).
In summary, the choice of interest rates looks like this. On the one hand, we can look forward through the windscreen and see that monetary growth has collapsed and the impact of past recent interest rates on the money stock has not even yet been fully felt. We can also note from the side window that general inflation has already further than the CPI suggests.
On the other hand, we can look back in the rear-view mirror at the CPI rate, or worse still the ‘core’ CPI measure, speculate about wage-price spirals and ‘stickiness’, and continue on into further monetary tightening in exact mirror reflection of the monetary mistakes made in Covid.
The decision lies, in principle with the Bank but the Exchequer sets its targets. It has the power at least to order that sleepy institution to look beyond CPI at house prices and the wider economy in measuring success.
Fortunately, the Fed has woken up to the need to ease monetary conditions. Will the Bank of England?
Sir Julian Brazier is a former Defence Minister, and was MP for Canterbury from 1987-2017.
Opinion is sharply divided between those who feel that the Bank of England has gone far enough on interest rate rises and those who believe that more needs to be done to slay the inflationary dragon. Interest rates, the principal monetary lever, are of course controlled by the Bank of England, which holds the statutory responsibility of keeping inflation close to its government-set target (currently 2 per cent).
Many Conservative commentators belong to the second school. For example, Ross Clark of The Spectator tells us that we are facing a wage-price spiral. Several of his colleagues have started describing certain price rises as ‘sticky’ in the magazine’s (otherwise brilliant) podcasts.
The old joke about economics being invented to make astrology respectable seems to be coming back into vogue. It is a generation since Margaret Thatcher abandoned all this Neo-Keynesian thinking, set her face firmly against prices and income policies, and made it clear that the key to tackling inflation was curbing the growth in money – or rather the gap between the growth in the money stock and the growth in the economy – too much money chasing too few goods.
This view has been broadly understood since the ancients and was developed in the 18th and 19th century, but its principal modern apostle Milton Friedman was critical to the former Prime Minister’s thinking. Let’s see what the money supply figures have to tell us both here and in America, whose economic cycle we so often follow.
During Covid, both the Bank of England and the Federal Reserve (“the Fed) printed money in industrial quantities, although the latter went much further with M2 growth peaking at nearly 27 per cent in January 2021, while our own M4 growth peaked at just below 14 per cent in March 2021. Not surprisingly, inflation took off in both countries and Neo-Keynesians belatedly joined the monetarists who had been warning for some time that action on interest rates (that is monetary action) was urgently needed.
Restoring interest rates to sensible levels followed. The question we started with – whether to continue or ease off – sharply divides those two schools of thought once again.
Neo-Keynesians believe in expectations driving inflation so pay rises, whether private or public, are inflationary. They see wage growth as increasing the persistence of inflation. Clearly, public sector pay policy is critical to fiscal policy, which underpins monetary policy, but monetarists reject any attempt to control private sector wages as pointless.
Instead, Margaret Thatcher, Geoffrey Howe, and Nigel Lawson focused on monetary growth. Today this has shriveled in the UK to 0.1 per cent per annum and has been below 2.5 per cent ince January. Across the Atlantic, M2 has been negative since January and in May shrank at its fastest rate since the 1930s. There are two further important factors – the additional time lag on mortgages and the measurement of inflation itself.
The transfer of most holders of mortgages, over the past generation, from variable to medium-term fixed rates has introduced a second-time lag into monetary policy. On top of the typical 18-month interval between monetary growth and inflation, painstakingly charted by Friedman, there is now an additional delay between interest rate movements and changes in the money supply itself.
The second key factor is how we measure inflation. The internationally recognised measure of the rate at which money loses (or gains) value is the GDP deflator, which looks across the economy as a whole. It is this overall measure which responds to monetary factors – rather than individual prices which may fluctuate heavily within it.
Unfortunately, measuring the GDP deflator is a long, slow business so it is published months behind and then subject to frequent substantial revision so – like other countries – we give our central bank a target based on a subset. In Britain and America, we have chosen to focus on consumer prices which often move collectively heavily out of line with other important parts of the economy like house prices, as has been the case both during Covid and over the past 6-9 months.
So, absent an up-to-date and reliable measure of the whole GDP deflator, to get a rounded view of where we are, we need to broaden the current narrow of prices at least to include house prices. As house prices are actually falling (here and in America) this would show general inflation to be substantially lower than the Bank is measuring it, in comparing it with its target.
A further twist to the current debate is that neo-Keynesian commentators, including those in the Bank, have now dreamed up a new even narrower measure – so-called ‘core inflation’ which excludes fuel and energy. No rigorous study has been advanced to suggest why this small, unrepresentative, group of price movements is representative of the whole (economists just observe that it fluctuates less quickly than food or fuel prices).
In summary, the choice of interest rates looks like this. On the one hand, we can look forward through the windscreen and see that monetary growth has collapsed and the impact of past recent interest rates on the money stock has not even yet been fully felt. We can also note from the side window that general inflation has already further than the CPI suggests.
On the other hand, we can look back in the rear-view mirror at the CPI rate, or worse still the ‘core’ CPI measure, speculate about wage-price spirals and ‘stickiness’, and continue on into further monetary tightening in exact mirror reflection of the monetary mistakes made in Covid.
The decision lies, in principle with the Bank but the Exchequer sets its targets. It has the power at least to order that sleepy institution to look beyond CPI at house prices and the wider economy in measuring success.
Fortunately, the Fed has woken up to the need to ease monetary conditions. Will the Bank of England?