Carry On Easing

07/10/2011 at 1:22 pm 1 comment

So Mervyn King and his team at the Bank have decided to carry on easing. Widely misrepresented by the shorthand of “injecting money into the economy”, we have looked before at what “quantitative easing” really entails and at the negligible effect it has had.

The justification supplied this time for the £75bn programme is that the UK economy has been growing terribly slowly and that it faces a serious financial crisis. Which is all very interesting, but is supposed to be secondary to the Bank of England’s mandate to keep prices stable, defined at present as delivering annual UK CPI inflation of 2.0%.

The Bank still pays lip service to this notion in a quarterly document it puts out called the Inflation Report which updates readers on its view of the economy and justifies whatever its current monetary stance happens to be by reference to its forecast for inflation. In November 2008, for example, when the base rate was cut by 1.5% (to 3.0%) in the wake of the Lehmans collapse, CPI was predicted on the Bank’s model to reach a woeful 1.0% by Q4 2010 (p. 47). In actual fact inflation averaged 3.4% over that period.

Now the end of 2008 was a rare old time. The financial system as we’d come to know it had burned to the ground, the world economy was in recession and stock markets were stampeding towards zero. Sterling had fallen sharply too. The Bank was on its way to a base rate of 0.5% and £200bn worth of bond purchases. So let’s look at the Inflation Report forecast of August 2009, at a time when the economy was returning to growth, stock markets were rallying, the pound had found a new level and the MPC had had nine months in which to refine their projections. Even with the unprecedented monetary stimulus, they said, inflation was going to fall steadily during the course of 2010 to about 1% before rising to a gentle 1.5% by August 2011 (p. 42).

Of course what happened was that inflation doubled over the next six months, has risen steadily since and by this August (the last count) stood at 4.5%. This level of inflation has decimated real wages and contributed to a double dip recession in the household sector. And it has proved the assumptions underlying Britain’s emergency monetary measures woefully wrong.

The Bank, in other words, has shown itself damagingly incapable of forecasting UK inflation. Another Inflation Report is due out next month. It is bound to project the return of CPI inflation to 2% in two years’ time – or even an undershoot requiring more QE. And who knows? Perhaps in August of 2013 we will have economic contraction, price inflation of 8% and Mr King’s successor throwing wads of fifties off the roof of Threadneedle Street, wondering why it all keeps going wrong.

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Lessons From The East Shipping Ahoy

1 Comment

  • 1. Bump In The Road « The Blog @ Vigilant Financial  |  27/01/2012 at 1:31 pm

    […] another cavalier display of pointlessness from the Bank of England in the form of more “quantitative easing“. Nor does it alter the fact that the UK’s debt burden is an ugly one and that we have […]

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