Across the pond on Thursday, the Bank of England struck a very different tone from its American counterpart the week before. Whereas the Federal Reserve was stuck walking back Chairman Jerome Powell’s equivocating about the future and implication of the central bank’s recent rate hike campaign, the U.K. bank’s Monetary Policy Committee emphatically committed to raising rates until it conquered Britain’s inflation crisis — and admitted the costs of doing so.
Although the U.K. bank’s rate hike of 50 basis points, bringing its bank rate to 1.75%, was actually less significant in comparison to the Fed’s second 75 basis point hike in a row, bringing the federal funds rate stateside to 2.5%, the British central bank explicated their expectation that culling inflation, projected to peak at a staggering 13%, would require more than a year of a recession due to begin later this year.
Without casting judgment on the U.K. bank’s decision, key Biden ally Jason Furman took to Twitter to deem it “extraordinary to see a Central Bank raising rates while forecasting -1.7% growth over the next three years while the unemployment rate rises from 3.7% to 6.3%.”
But is it, though? Or is it utterly obvious to any honest broker of monetary policy that the only way out of an inflation crisis is through the tragedy of a painful economic contraction, as has been true of every modern case of central banks flooding an economy with excess fiat currency?
As with the case of American inflation (and indeed all inflation), the current bout of British inflation is a monetary phenomenon. The United Kingdom’s M2 money supply exploded by 20% from February 2020 to the end of last year, and the U.K. bank’s reserve balance doubled since the pandemic. Now, even with inflation slated to remain in the double digits through next year, the central bank has committed to seeing its rate hike campaign, the largest in over a quarter century, through a full-scale recession. That’s because although economic contraction may not be the cure itself to inflation, it’s a necessary and unavoidable side effect of the cure for inflation: constricting the money supply.
It’s not just progressive purveyors of Magical Modern Monetary Theory such as Stephanie Kelton who have denied the reality that inflation is always a result of increasing the money supply and, thus, debasing a currency. Before these rising prices, Powell claimed the link between the money supply and inflation ended 40 years ago, or about the last time the Fed was forced to halt the economy into the red. And yet the cycle has remained as predictable as it was when Milton Friedman famously branded the “inflation or unemployment” trade-off a “false dichotomy” (one that’s still being peddled by such progressives as Sen. Elizabeth Warren today): Monetary expansion has been followed by economic expansion, which is followed by inflation and then the Fed’s tough medicine of slowing monetary growth and a recession.
The anomaly that was the 2008 financial crisis conned an entire expert class into believing that flooding the economy with cash via near-zero interest rates amid a decade of a bear market and unprecedented quantitative easing would have negligible inflationary consequences. Perhaps that was true to a point, the real and enduring economic output of the pre-pandemic era, reflected by a renewal of real wage growth, but the central bank’s response to the coronavirus was practically a recipe for runaway inflation. Not only did it print a quarter of all dollars in circulation today just since the pandemic, but it also did so while the government artificially suppressed output via lockdown laws, encouraging boomers to exit the workforce earlier by hastening their retirements and mothers to trade in their stilettos in the C-suite for returning barefoot to the kitchen to accommodate school closures.
The Fed spent a decade chasing the white whale of “full employment,” ignoring the second half of its dual mandate, inflation. The British central bank will ignore all else to restore the latter, and despite its refusal to embrace the candor of its U.K. counterpart, so will the Fed. That is because without stable and low inflation can persist with low unemployment, low unemployment cannot persist without stable prices.
The next time a politician warns the public that our monetary policy grants too much credence to inflationary fears, as Warren did during her presidential campaign, perhaps they ought to consider why we avoid inflation at all costs. As though inflation were cancer, the most dangerous form of growth our economy can suffer, the cure is as painful as chemo. This time, we must hope our central bankers maintain the resolve to see the treatment kill the disease even as it wrecks our economy. The Bank of England clearly understands this. Let’s hope our Fed does as well.
