When did central banks decide that abnormal monetary growth doesn’t matter anymore?
With many countries’ economies still suffering from the effects of the coronavirus pandemic, or even — as in the UK — still under large-scale lockdown, another fall in spending and output in the autumn is expected.
Worryingly, policymakers around the world only seem to be concerned about the short-term impact of the lockdowns, and appear to be disregarding the effects in the medium and long term which the increase in the amount of money since March 2020 is likely to cause in 2021 and 2022.
Since March 2020, there has been a marked acceleration in money growth in most advanced economies. The latest figures show that annual growth in the amount of money (broadly defined, to include bank deposits) stands at 9.5 per cent in the Eurozone, 7.4 per cent in Japan, 11.6 per cent in the UK, and a truly exceptional 23.5 per cent in the US.
Do these figures matter at all? If one is concerned about the effects of excessive money growth over prices and the business cycle over the medium term, the answer is yes.
And yet, in its November meeting, the Bank of England’s Monetary Policy Committee voted unanimously to increase its asset purchase programme by £150bn and did not even mention the quantity of money in the analysis of recent developments in the UK economy.
Given that the rate of growth of money is already too high, this month’s boost to quantitative easing was unnecessary. The Bank seems to be suffering from too much short-termism in its analysis and cannot see the wood for the trees when it comes to monetary policy.
For an advanced economy to grow at a sustainable and non-inflationary rate over the medium and long term, the annual rate of growth in the amount of money should not rise consistently above five or six per cent. This is a “reference band” compatible with trend economic growth (around two per cent) and stable inflation of two per cent per annum.
At the moment, the rate of growth of money is double that band in the UK, and four to five times higher in the US. This will most likely have consequences on inflation and the business cycle in the medium term.
True, we have data showing that households, businesses and financial companies are holding higher than normal amounts of cash, if only for precautionary reasons, such as fear of redundancy. This is producing a significant fall in the circulation of money in the economy, which in turn is holding prices down.
However, this situation is not likely to continue for long. Once the worst of the pandemic is under control and markets reopen for business as normal, those agents will not wish to keep these extraordinarily high levels of cash “in their pockets”. The amount of money created since March 2020 will not have evaporated.
It will be at this point that we see an abnormal growth in spending and nominal national income in the major economies, particularly in the US, which will most likely be followed by inflation.
It is not too late to prevent this, but it requires central banks to act quickly. If we are to avoid higher inflation in the UK (indeed, far above the Bank’s target), this process needs to start as soon as the worst of the pandemic is over.
Central banks should return to a monetary theory of inflation, so that they can incorporate the effects of changes in the supply and demand for money in prices and output into their analysis and policymaking decision processes. This is the best way of ensuring that the economy will remain stable, now and in the future.
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