This brings me to the second crisis – inflation itself. When real incomes are squeezed, it is understandable that people try to protect their standard of living by raising their wages, which then leads to higher prices, and so on. It’s an inflationary problem, pure and simple, and there’s a lot central banks can do about it.
But make no mistake, if the authorities took strong measures to stop the inflationary spiral, it would affect both price inflation and wage inflation. A much tighter monetary policy could reduce inflation, but it would not ease the pressure on living standards.
There is a clear parallel to the oil price hikes of the 1970s. These imposed the same spike in costs and real revenue losses across the developed world. But due to policy differences, inflation in Germany remained well below that of the US and UK.
So, is the Bank responsible for the current inflation? To some extent, yes. There has been a failure of foresight, understanding and policy. The Bank’s biggest forecasting error was not to anticipate the tightening of the labor market. Certainly, he was not alone in this case. (I also plead guilty.)
And we have to remember that during the pandemic, it was extremely difficult to predict how the economy would perform. It is quite understandable that the Bank was very concerned with preventing the collapse of the economy. In this regard, it was closely aligned with other central banks.
My criticism of the Bank’s performance relates to how long it took it to recognize that the labor market was tight and to recognize the severity of the inflationary shock that was working its way through the system. Moreover, when the penny began to drop, his actions were no match for the danger at hand.
The result is a real threat that inflation expectations will become unbalanced. Witness the current feeding frenzy in much of the housing market.
In view of all this, the credibility of the Bank has been seriously undermined. It is possible to say that having made this mistake, rather than rushing to correct it, the Bank should do nothing more.
Indeed, central banks could be on the brink of another major mistake by raising interest rates too much and thus exacerbating what already looks like grave danger of recession.
This is precisely what some monetarists now argue, given that rates of monetary growth have fallen sharply and, in some cases, have turned negative.