The Bank of England’s Failure: baked in inflation is making us all poorer

The Adam Smith Institute on Bank of England rate rises amidst high inflation and excessive Quantitative Easing.

With CPI rising to 10.4%, inflation is more baked in than many imagined. Inflation is most hurtful to the poor and vulnerable in our society, who are least able to afford price rises or renegotiate their pay. The Adam Smith Institute wants to see:

1. The Bank of England answer for its abject failure in meeting its 2% target and recognition that they were too slow and timid in managing inflation.

2. Central bankers refocus on the core types of money (such as M1 and M2), which were neglected despite huge spikes, a key cause of current inflation.

3. Caution against overcompensating now (through excessive rate rises), needlessly risking financial stability, and prompting bank runs, and a recession.

4. The government helping to counter inflation, with supply side and planning reform - not further boosts to demand that distort the economy and fail to fix the root problems in the UK economy.

CPI rising to 10.4% shows that inflation is more baked in than many imagined. The rise prolongs our cost of living crisis, punishes savers, makes goods increasingly expensive, and encourages public sector strikes as workers seek higher wages to compensate.

Inflation is most hurtful to the poorest in our society - those least able to afford price rises or renegotiate their pay. It is a moral failing of policy and leadership that the most vulnerable take on a disproportionate share of the burden.

We cannot continue to sit idly by and expect the problem to fix itself. The ASI believes there has been an abject failure of monetary policy. Although the Bank of England has independence to make rate decisions, they have materially failed to meet their 2% target. This alone should prompt the resignation of the Governor, Andrew Bailey. However, with Number 10 redirecting flak to external supply side shocks, the Old Lady of Threadneedle Street has been cleared from blame in the press and politics.

Inflation was not a transitory problem, or simply the result of Ukraine and supply shocks, but a failing of central bankers. Monetary policy was too loose in the US and UK, with a huge spike in M2 money supply during Covid. The Federal Reserve and Bank of England were too slow and too timid to raise interest rates.

The Bank of England and its peers have serious questions to answer. Central banks must stop neglecting monetary theory and re-focus on money supply metrics. It is perhaps revealing that the Federal Reserve even discontinued weekly measures of money supply (M1 and M2) in January 2021, just after they spiked and provided a clear warning sign of the inflation which would follow. Likewise, the long-run pumping of M4 (broad money) propped the economy on credit-based stilts, meaning that it remained exposed across all sectors to external shocks.

Worryingly, central bankers now risk over compensating, with rates increasing and therefore monetary policy tightening too aggressively - a key historical cause of self-inflicted bank runs and recessions. One US measure of money supply (DM4) recently declined year-on-year, its largest fall in over a decade, a worrying omen: such declines have been followed by bank runs and recessions in the past Without a proper focus on money supply, the Bank of England risks needlessly damaging financial stability, prompting avoidable bank runs or causing a recession.

Our government can help counter inflation too, by revisiting supply-side and planning reforms. For example, if the UK builds more houses, creates more childcare capacity in nurseries, and rapidly approves and builds more nuclear energy, the price of these goods will come down. Some measures in the recent budget were targeted at the right areas (e.g. childcare), but by focusing on demand not supply, failed to fix the root issues.

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For further comments, please contact Director of Communications Connor Axiotes on connor@adamsmith.org, or 07584 778207.

Simplify the Tax System - Maxwell Marlow on BBC's Sunday Morning Live

Our Director of Research, Maxwell Marlow, debates the ethics of taxation on the BBC’s Sunday Morning Live.

UK about to fall behind Poland - tax and red-tape is killing us

Our Director of Research, Maxwell Marlow, writes in the Express about the UK’s woeful economic performance and how even Poland is out-growing us. But Max explains there is a path back to economic vigour, and it lies in sound economic policy:

UK about to fall behind Poland - tax and red-tape is killing us, says MAXWELL MARLOW

As the Chancellor pores over his papers ahead of the budget, British businesses are concerned that they will be left in the cold.

Our Forgotten Medium event in Westminster was a hit

Duncan Simpson, Minister Kevin Hollinrake MP, Saqib Bhatti MP and Richard Harpin provided great analyses of our new report Forgotten Medium: Helping Mid-Sized Businesses to Scale Up.

The Forgotten Medium: Helping Mid-Sized Businesses to Scale Up

A new report from the Adam Smith Institute co-authored by our Executive Director, Duncan Simpson; Director of Research, Maxwell Marlow; and Head of Research, Daniel Pryor, finds that medium-sized businesses (MSBs) and their size-specific challenges are often neglected in public policy debates. MSBs are the “Forgotten Medium”.

• Focus is skewed towards both the smallest and largest companies in the UK, who benefit from support not offered to the “Forgotten Medium.”

• Scaling up MSBs would boost the UK’s growth prospects, in particular in areas of ‘levelling up’ concern. 

• Over 83% of MSBs are outside London and the South East. Their products are overwhelmingly in non-services sectors such as retail, wholesale, and transport.

• The following policy changes can alleviate these problems:

  • Implement a recommendation of the 2019 Augar Review for a lifelong loan entitlement. This would allow for 4 years of post-18 education over the course of a lifetime, allowing individuals (especially in MSBs) to re-skill. 

  • Enterprise Investment Allowance & Venture Capital Trust schemes should be modified to remove the cliff-edges facing MSBs who partake in them. To keep current and potential investors, the number of employees allowed should be raised to 999 from 249, as well as increasing the turnover and balance sheet totals.

  • High Potential Individual visas should have a widened list of elite universities and a lower application fee to attract more high-skilled foreign labour. 

  • The Annual Investment Allowance should be made unlimited from its current level of £1 million. This would improve the growth prospects of MSBs, especially in capital intensive industries.

Richard Harpin, entrepreneur and founder of HomeServe, said of the Adam Smith Institute’s new report:

“Successive governments’ growth policies have overly focused on the biggest corporates or the smallest start-ups.  Yet it’s Britain’s tens of thousands of medium-sized businesses that are the lifeblood of the economy and key to more jobs, productivity, and growth.

“Growing HomeServe from an idea into a FTSE 100 company took 27 years but making the jump from medium to large was by far the biggest challenge. Just when businesses are on the cusp of something great, the policy support plug gets pulled.

“The Adam Smith Institute is spot on: if we want to catch up with the rest of Europe, Britain needs to rethink how it supports this crucial yet neglected segment of the economy.”

-ENDS-

Notes to editors:

• For further comments or to arrange an interview, contact Connor Axiotes, connor@adamsmith.org | 0758 477 8207.