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Collective amnesia on money supply hit BoE inflation response, says Mervyn King

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The Bank of England’s failure to forestall the post-pandemic surge in inflation was the result of collective amnesia in the economics profession about the role of money supply, according to a former governor.

Lord Mervyn King, who led the UK’s central bank between 2003 and 2013, said on Thursday it was “troubling” that when prices began to rise in 2020 and 2021, there had been “no dissenting voices to challenge the view that inflation was transitory” among policymakers on either side of the Atlantic.

King, speaking in a debate in the House of Lords, said the BoE had “tarnished” its record by keeping interest rates low even when it became apparent that price pressures were intensifying.

Inflation rose to a peak of 11.1 per cent in late 2022, King said, because policymakers had ignored the likely impact of a “very substantial” monetary and fiscal expansion boosting demand, even as lockdown curbs restricted supply — a mistake made by other central banks and academics.

“Too much money chasing too few goods is and always has been a recipe for inflation,” he said, calling it “foolish” for central banks to rely on forecasting models that ignored the role of money entirely.

“The academic economics profession has essentially jettisoned the idea that one might ask what the growth of broad money [a measure of the amount of money circulating in the economy] was telling us,” King said, adding that this consensus had “led to the problems we are now too familiar with”.  

The BoE’s Monetary Policy Committee is expected to keep interest rates at a 16-year high of 5.25 per cent next week, although some members have suggested they are ready to vote for a cut, with inflation likely to fall close to their 2 per cent target in the near term.

King, who as governor led the BoE’s response to the 2008-09 financial crisis and shaped much of its current approach to communication, also struck back at recent criticism of its methods from Ben Bernanke.

He cited in particular the call by the former US Federal Reserve chair for the BoE to scrap the “fan charts” it uses to depict uncertainty around its forecasts.

“The mistakes of 2020 and 2021 were not the result of presentation. The Bank might have used fan charts, the Fed used dot plots. It didn’t make any difference. They both made the same misjudgement,” said King. “What really matters are judgments about the state of the economy and the way monetary policy works.”

King’s arguments were echoed by other members of the House of Lords economic affairs committee — including former chancellor Lord Norman Lamont, who first introduced an inflation target for the BoE in 1992, at a time when regimes targeting measures of money supply were widely discredited.  

BoE governor Andrew Bailey told the committee this year that the central bank looked at money supply as part of its modelling process “and always [had] done” but that “on its own, it is not as good a forecasting tool as some of the commentary sometimes makes out”.

The UK pursued a policy of money supply targeting in the 1970s and 1980s but abandoned it during the chancellorship of Nigel Lawson.

It went on to pursue policies focused on exchange rate pegs that culminated in the country’s exit from the Exchange Rate Mechanism in 1992, before adopting the price growth target.

But Lamont said that even after introducing this framework, the inflation target had been accompanied by “target ranges for monetary aggregates”.

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