Updated: Dec 30, 2022
The QE response by the Bank of England during the Pandemic has prompted debate from Economists such as Tim Congdon from the IIMR to challenge the Bank of England's Monetary Policy doctrine. The idea that inflation has always been a monetary phenomenon has seen a resurface as the new-Keynesian doctrine is beginning to have many of its flaws brought to light. In particular, during the pandemic, the Bank of England’s interest rate-focused policy direction failed to account for the inflation caused by its Quantitative Easing programme. (IIMR, 2022) As such, the following column will highlight the importance of stable M4 growth over the last decade as well as its more detrimental and inflationary effects during the COVID-19 crisis.
Historic data shows that the UK M4 money supply has risen in the last decade (Figure 1) due to the private money creation carried out by financial institutions. The UK FTSE 100 index has risen in the last decade, (Figure 2) however, compared to GNI and household expenditure, the index is much more turbulent with the market slipping due to the fallout of the financial crisis, the confidence loss of the Brexit referendum, and, now, the pandemic. Looking at UK GNI (Figure 3) and final household consumption (Figure 4), both of these have been increasing. The growth of these indicators, is, in the long-run, inherently linked to the stable growth of M4. This is because as private money is created in the economy, usually in the form of debt or credit, the increase in the supply of money yields the real balance effect. A scenario whereby an agent has more money than national income. With this, surplus money is distributed to other economic agents within the industrial circulation, minimising the surplus money of each individual agent. However, because now all agents suffer from more money than national income, price levels rise within the economy to accommodate for the increased supply of money broadly defined to reach a new equilibrium. This is one of the reasons why historically, since the Bank of England's independence, the UK rate of inflation has averaged within the symmetrical CPI target. (Figure 5) Inflation is a monetary phenomenon dependent on a stable growth of M4. Hence, when M4 rises at a stable rate, data from the last decade shows that expenditure, national, or nominal, income, as well as asset and CPI prices, follow a similar trend.
However, during the pandemic, QE efforts undergone by the MPC caused an increase in M4 liabilities to the financial sector & households that deviated from the steady growth rate. (Figure 6) Hence, the real balance effect can also be borne by financial institutions, especially during times of expansionary monetary policy. The increase in liquidity promotes the purchasing of assets such as equities which explains the continued historic rise in the value of the FTSE 100 as well as the moderate recovery of the index almost instantly post QE. (Figure 2) When this occurs, investors, or households, may choose to liquidate their better-performing assets, transferring the surplus money to the industrial circulation through expenditure on goods which typically takes 2-3 quarters. Such a trend lines up with these predictions as in the case of the pandemic household expenditure spiked in Q3 of 2020 (Figure 4) with GNI following a similar pattern. (Figure 3) Similarly, the time lag for higher CPI prices to manifest also followed the monetarist time lag. With M4 increasing during the first quarter of 2020, (Figure 6) inflation rates broke above target in the second quarter of 2021 with higher than 3% CPI inflation occurring in the third quarter, (Figure 7) representing a time-lag of 6 quarters and inflation rates breaking above target. A policy failure by the Bank of England.
IIMR (2022). IIMR July 2022: 'Do Interest Rates or the Quantity of Money Determine Demand growth?'. Tim Congdon. [online] www.youtube.com. Available at: https://www.youtube.com/watch?v=14ZDFYqTJJ4&t=1s.
Figure 1, Available at: https://www.bankofengland.co.uk/boeapps/database/fromshowcolumns.asp?Travel=NIxAZxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2010&TD=11&TM=May&TY=2025&FNY=Y&CSVF=TT&html.x=66&html.y=26&SeriesCodes=LPMBD93&UsingCodes=Y&Filter=N&title=LPMBD93&VPD=Y
Figure 2, Available at: https://www.londonstockexchange.com/indices/ftse-10
Figure 3, Available at: https://www.ons.gov.uk/economy/grossdomesticproductgdp/timeseries/abmz/ukea
Figure 4, Available at: https://www.ons.gov.uk/economy/nationalaccounts/satelliteaccounts/timeseries/abjr/pn2
Figure 5, Available at: https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/l55o/mm23
Figure 6, Available at: https://www.bankofengland.co.uk/boeapps/database/fromshowcolumns.asp?Travel=NIxAZxSUx&FromSeries=1&ToSeries=50&DAT=RNG&FD=1&FM=Jan&FY=2010&TD=11&TM=May&TY=2025&FNY=Y&CSVF=TT&html.x=66&html.y=26&SeriesCodes=LPMVQKA&UsingCodes=Y&Filter=N&title=LPMVQKA&VPD=Y
Figure 7, Available at: https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/l55o/mm23