Did central banks cause today's inflation spiral?

Did quantitative easing (QE) contribute to today’s rampant price growth? The jury (well, the Treasury Committee), is still out. Views are currently being collected on “the impact of QE on the ongoing outbreak of inflation”. 

In the pandemic, a meme emerged. On the left-hand side, a worried figure warns that creating money cannot fight an economic downturn and would distort the natural rate of interest. On the right-hand side, a Federal Reserve representative replies “haha money printer go brrrr”. Were central banks really too cavalier about ‘unconventional’ monetary policy? The Bank of England (BoE) seems to think not. 

Last month, outgoing BoE monetary policy committee (MPC) member Silvana Tenreyro stressed in a speech that QE does not represent “money printing”, but rather a like-for-like “asset swap” between interest-earning reserves and government bonds. As a result, “the net amount of assets and liabilities held by the private sector and held by the consolidated public sector remains unchanged”, she said. Tenreyro added that “QE affects the economy only to the extent it affects interest rates. There is no separate ‘money’ channel that can unleash inflation”. 

Last week, deputy governor Ben Broadbent said that the perceptions that QE leads to rapid growth in the money supply and excessive inflation “are not well supported by the evidence”. Broadbent said that broad money grew more than twice as fast in the first 15 years of inflation targeting (when there was no QE) than in the decade or so after the financial crisis (when there was plenty). What’s more, inflation averaged close to 2 per cent in both periods. Hardly a smoking gun.

But that doesn’t mean that it was well deployed. It has long been acknowledged that QE has a greater impact at times of market stress, meaning not all rounds are created equal. Ex-MPC member Andrew Sentance told the Treasury Committee that “it did seem that QE went on for too long and there was too much of it in the pandemic period”. He added “that long period of very loose monetary policy, plus what was done in the pandemic has, in my view, quite significantly contributed to the inflation we are now experiencing”. 

Gerard Lyons, chief economic strategist at Netwealth, dubbed the UK’s various rounds of QE “the good, the unnecessary and the bad”, telling the committee that inflation has taken hold “both because of supply shocks and inappropriate monetary policy”. Lyons said that while QE formed part of a ‘good’ policy response to the financial crisis, “it was very evident soon after the latest shock took hold that it was very different”. He added that the BoE stuck with this ‘bad’ tranche of QE, “even though it was quite clear that it was not only not working but exacerbating the situation”.

That is not to say that QE is to blame for all of today’s inflationary woes. Katharine Neiss, chief European economist at PGIM Fixed Income, told the committee that QE is designed to ease financial conditions and support the real economy – and therefore to push up on inflation. She added that although it has “undoubtedly contributed to the inflation we have seen over the last several years”, there are other contributing factors, not least higher energy prices. “It is very difficult to unpick the impact of those,” she said. 

Jagjit Chadha, director of the NIESR think tank told the committee that although loose monetary policy likely pushed inflation higher than it otherwise would have been, the primary cause of today's inflation is supply shocks. The BoE’s Broadbent also noted that if inflation was money-driven, we would expect all prices to be affected equally. In reality, we have seen substantial shifts in relative prices, particularly the cost of imported food and energy. The latest monetary policy report shows that energy has been a significant driver of UK inflation (see chart).

This doesn’t mean central banks are off the hook. Last month, Agustin Carstens, general manager of central bank umbrella body BIS, argued that policymakers must face some of the blame for today’s inflationary pressure. Carstens said that “the monetary and fiscal policy stimulus deployed during the pandemic gave inflation an even larger, and certainly more enduring, unexpected push”. He said that “with the benefit of hindsight, it is now clear that policy support was too large, too broad and too long-lasting”.