German economist Karl Otto Pöhl famously described “inflation as being like toothpaste. Once it’s out, you can hardly get it back in again. So, the best thing is not to squeeze too hard on the tube”. Although the quote stretches back to 1980, are we still seeing the Bank of England squeeze on the tube and drown the economy in toothpaste?
Without a doubt, the past few years saw us witness supply side shocks that the Bank of England could not have forecasted. This is especially relevant to the UK due to dependence on imports. Firstly, China’s stringent zero Covid-19 policy created a supply chain bottleneck, impacting the world economy as China accounts for almost a third of global manufacturing output. Globalised, complicated supply chain networks are unable to respond as quickly, due to the nature of such networks relying on just-in-time production. In addition to this cause of inflation, geopolitical tension and especially the war in Ukraine has had a deep profound impact on the inflation rate. After the ban imposed by the UK government on the 8 March 2022 on Russian oil, energy prices skyrocketed, and the impact on prices can be seen in figure 2. With energy costs amounting to over 10 percent of total costs in nearly a quarter of UK businesses (with greater exposure among small businesses), pass- through from high energy prices to domestic goods and services is estimated to have added about 1 p.p. to core inflation in 2022.
Another origin of inflation that Andrew Bailey has strongly emphasised is wage growth due to future expectations for inflation to continue to increase. The fall in unemployment and surprising labour market resiliency within the UK has seen high wage growth, with the annual percentage change on nominal wage reaching a peak of 8% in the third quarter of 2023. Although we are thankfully not experiencing a wage price spiral, the cloud of uncertainty about the labour market and the effects of high bargaining power has seen real wages increase without any meaningful increase in the real GDP, contributing to the period of high inflation. Thus, there were a multitude of supply-side surprises that the Bank of England could not have anticipated for, leading to a strong case that we were navigating through challenging waters. Eurozone countries and the US have also experienced similar levels of inflation in the past few years have also experienced this inflation episode, as shown in figure 3, possibly suggesting that this was merely a unprecedent and volatile couple of years for the macroeconomy, and the Bank of England had very little responsibility.
^ Figure 3: Core inflation in the UK in comparison to similarly developed economies (The White House, 2023)
On the other hand, there is also a case for the Bank of England being irresponsible in its conduction of monetary policy well before the inflation episode. In fact, some would go as far as to say the bank has blamed inflation on just about everything other than the Bank of England.
Following the Global Financial Crisis, the global economy was in deep recession and in desperate need of something to kickstart weak levels of demand. Even lowering the discount rate to levels of 0.1% did not prove to do much in encouraging consumption to increase, leading to the problem of zero lower bound interest rates. It was clear that another monetary tool was needed, which turned out to be quantitative easing, a form of a permanent open market transaction. Also known as “money printing”, QE involves central banks digitally creating money in the form of central bank reserves, which is used to purchase gilts, treasury debt and corporate bonds from private investors. There is a dual effect as both the long-term interest rates for these bonds decreases due to the price of the bonds increasing, whilst also the money supply is increased as liquidity in the market increases so borrowing becomes cheaper. Both consequences stimulate the economy and proved tremendous in helping the UK to recover from recession. Using quantitative easing over the past decade, the bank created and pumped into the U.K. economy around $1.17 trillion, a sum equivalent to more than a third of the country’s GDP. Whilst initially QE was used to remove the fear of economic contraction, econometric studies highlight that further round of quantitative easing had smaller impacts.
Fast forward to the recent inflation episode and the large increase in the money supply caused by QE will have aided the inflation episode, due to the monetary excess injected into the economy. We could potentially argue that this mismanagement of monetary policy has been exaggerated by the recent supply shocks as with the hike of interest rates to 5.25% from record lows observed a few years earlier, firms and consumers no longer have access to cheap borrowing, leading to numerous insolvencies and falls in savings. In addition, markets are witnessing distortions and asset bubbles, further signs of turmoil. With only 40% of economists surveyed predict central banks will use QE the same way as they did before, there is a strong case to be presented that relaxed quantitative easing was taken too far.
During the COVID-19 pandemic, laissez-faire economists would argue that monetary policy was once again excessive and intervention in the economy only delayed inflation, instead of tackling the root of the problem. The Bank of England’s Covid Corporate Financing Facility worked through the purchasing of commercial paper to fund capital for struggling companies. This has led to some struggling “zombie” companies staying afloat when they should collapse under traditional free market forces. Just as the Global Financial Crisis featured loose monetary policy in the form of subprime loans being offered to consumers with patchy credit, leading to defaults, this recent inflation episode can be said to have occurred due to relaxed monetary policy again that led to the emergence and possible addiction to QE as a method of aiding the increase in consumption.
In conclusion, the Bank of England could be repeating mistakes from the past where it provides too much liquidity to the economy and then races to pursue quantitative tightening, when it is too little, too late.
jet.sun 
Shahvez Ali