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  • Writer's pictureSteve Crowther

Thought for the Day: Inflation - monetary policy and the central bank


Methods of controlling inflation:


1. Monetary policy – Higher interest rates reduce demand in the economy, leading to lower economic growth and lower inflation.

2. Control of money supply – Monetarists argue there is a close link between the money supply and inflation, therefore controlling money supply can control inflation.

3. Supply-side policies – policies to increase the competitiveness and efficiency of the economy, putting downward pressure on long-term costs.

4. Fiscal policy – a higher rate of income tax could reduce spending, demand and inflationary pressures.

5. Wage/price controls – trying to control wages and prices could, in theory, help to reduce inflationary pressures. However, they are rarely used because they are not usually effective.


Monetarism is an economic view associated with early Thatcherism, Milton Friedman, rejection of Keynesian economics – government intervention during an economic downturn, neoliberal survival of the fittest and when ‘controlling the money supply’, don’t print the stuff. I agree with the last bit.

Supply-side policies may enable the economy to become more competitive and help to moderate inflationary pressures. For example, more flexible labour markets may help reduce inflationary pressure. Presumably this means ‘allowing companies to make changes such as employee hiring and firing, compensation and benefits, and working hours and conditions.’ How about investing in the workforce: decent living wages, flexible working hours for mothers (and carers), legal right to join a trade union. Over to you Mick.


Fiscal policy = higher taxes = less disposable income for the wealthy = no chance, we have a Conservative government.


Wage control deserves an economic blog all to its lonesome. This leaves us free to look at:


Monetary policy


This is the Central Bank’s analysis: ‘In short, higher interest rates will work because they will mean that less money will be spent in the UK (than if interest rates had not changed). When overall spending in the economy falls, price rises slow down. And this brings down the UK's inflation rate.’


Here is what it means:

Higher interest rates make borrowing more expensive and saving more attractive (in theory).

Homeowners will have to pay increased mortgage payments, leading to less disposable income to spend. This applies to those in rented accommodation as well. Therefore, households will have less ability and incentive to spend (we are skint).

So, higher interest rates are an effective, if somewhat blunt tool for slowing down consumer spending and investment, leading to a lower rate of economic growth. And as economic growth slows down, so does inflation.


On the plus side, higher interest rates will presumably mean a higher exchange rate which will attract ‘hot money’ ie short-term inward capital and cheaper imports. I know…it is also good for, you guessed it, the banks themselves. Higher interest rates = increased profits.


In 1997 Chancellor Gordon Brown (and Ed Balls) gave the Bank of England operational independence over monetary policy. Under Brown's proposal, the Bank had a legal obligation to hit the government's inflation target. Those responsible for setting interest rates were to be interrogated by MPs; the governor would have to write a letter if inflation deviated more than a percentage point from its target. The argument for an independent Central Bank is that it will be free from political pressures and avoid making mistakes like cutting interest rates before an election to curry favour with voters. And it is accountable. The government can influence the direction of travel by increasing taxation, for example. But this does have political implications…


The Central Bank has failed, it did not do its job. I am not interested in the very real external factors – Covid, Brexit or Ukraine, fuelling the upward drive. It did not act quickly enough or decisively enough (as The Fed did do). It did not do its job. But it is worse than that. The Central Bank under Andrew Bailey’s stewardship lost the plot; they did the one thing you do not do, they printed money. Calling it ‘quantitative easing’ may sound sexier, but it is utterly irresponsible given that their sole economic brief is to control inflation. Don’t take my word for it, take Huw Pill’s, the then central bank's chief economist.


‘Speaking to the House of Lords economic affairs committee, Pill admitted the Bank played a part in driving up inflation through its massive money-printing programme. Known as quantitative easing (QE), this pumped £450 billion into the economy during 2020.’


The governor Andrew Bailey should indeed ‘have to write a letter’ of explanation, quickly followed by an apology and a letter of resignation.

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