The Bank of England needs to provide a better justification for believing the rise in inflation is temporary, according to an influential parliamentary committee, which also queried the need for continued quantitative easing.
The House of Lords economic affairs committee, which includes former BoE governor Mervyn King, said on Friday that the BoE had failed to justify its flagship QE policy — the practice by which central banks seek to stimulate spending by creating money and pumping it into the economy by purchasing assets.
Lord Michael Forsyth of Drumlean, chair of the economic affairs committee, said that the bank “has become addicted” to quantitative easing, using it as the “answer to all the country’s economic problems”, and facing few questions despite its “eye-watering” size.
He added that there were “risks, given where the economy is, that inflation could take off” and while the bank says that it will be temporary, it should spell out “the plan if it turns out that is not the case”.
The committee’s report will sting inside Threadneedle Street, since one of the authors is King. Another is Nicholas Stern, former chief economic adviser to the Treasury and chief economist of the World Bank.
The report said that if the BoE “does not respond to the inflation threat sufficiently early, it may be substantially more difficult to curb later”.
During the committee’s inquiry, members interviewed many prominent experts including former central bankers from the Federal Reserve, the European Central Bank, the Bank of Japan and BoE, concluding that the latter must do more to spell out the side-effects of QE and reassure on its independence.
Official data revealed this week that annual consumer inflation jumped from 0.4 per cent in February to 2.5 per cent in June in the UK, well above the BoE’s target of 2 per cent and far higher than its recent forecasts.
The report noted that the QE impact on inflation was unclear but concluded that the latest round could be inflationary as it coincided with a growing economy, substantial government spending and very high levels of personal savings.
“Given where the economy is at the moment with inflation picking up, shortages of commodities, large amounts of savings, is it really necessary to do vast tranches of QE?” asked Forsyth. He added that if that was the case, the BoE should explain why and how that related solely to maintaining price stability.
The report flagged that the BoE was “widely perceived” to be using QE to finance the government’s deficit during the pandemic, as the central bank’s bond purchases were aligned closely with the speed of issuance by the Treasury.
It also noted that prolonged high inflation could “undermine” the bank’s hard-won independence, because it “may come under political pressure” not to raise interest rates when needed for price stability, as that would mean higher debt costs for the government.
“If perceptions continue to grow that the bank is using QE mainly to finance the government’s spending priorities, it could lose credibility destroying its ability to control inflation and maintain financial stability,” stated the report.
By the end of 2021, the bank will own £875bn of government bonds and £20bn in corporate bonds, equivalent to about 40 per cent of GDP, as part of the QE programme aimed at stimulating the economy by promoting lending, investment and consumption.
The report also calls for the BoE to outline a road map that demonstrates how it intends to unwind QE and to engage more openly about the side-effects of the programme, particularly inequality.
It suggested that QE artificially inflated asset prices, such as shares and house prices, which had disproportionately benefited those owning them, exacerbating wealth inequalities.
“Just ask any youngster trying to buy a flat and they will tell you about the impact of QE,” said Forsyth.
The BoE rejected the committee’s conclusions, saying it was “wrong” to suggest QE was designed to finance the government. It added that in the economic recovery, “the MPC will continue to assess the outlook for inflation and economic activity and to set monetary policy as necessary in order to achieve a sustainable return of inflation to the 2 per cent target”.
View original post