As Brits lined up for their jabs and the pandemic appeared under control, central bankers went from worrying about how to prop up the economy to worrying about how to stop it overheating.
But, as the then chief economist at the Bank of England Andy Haldane wrote for the New Statesman in June, the country’s economic recovery presented a new problem.
At the start of the pandemic in early 2020, as the economy teetered, the Bank of England committed to buying hundreds of billions of pounds’ worth of bonds from the government and financial institutions.
This quantitative easing (QE) was necessary to promote spending and investment and therefore to stimulate the economy. The other effective lever of monetary policy – lowering interest rates – was pulled all the way down after the financial crash in 2008-9 and has remained on the floor ever since.
But QE also increases the money supply, which can lead to inflation.
At the same time, the return to something like normal life unlocked much pent-up consumer demand while supply chains were still trying to manage the disruption caused by the pandemic.
These factors combined with a spike in the cost of gas, forcing up the cost of factory goods, food and fuel.
Some initially speculated that a little “transitory” inflation might not be a bad thing. Inflation refers to the price of things going up; if it’s the price of your own labour (ie your wages) rising, that’s not a bad thing. But such rises rarely happen in isolation. A shortage of taxi drivers, for example, is related to fuel being very expensive, and doesn’t mean the remaining taxi drivers get rich off higher fares.
But inflation has already risen more steeply than expected, hitting a ten-year high in November at 5.1 per cent. The Bank of England’s target is 2 per cent.
The risk is that the transitory spikes in prices – for example, of goods such as second-hand cars – spread across the economy. For instance, a lot of people rely on a second-hand car to get to work: if second-hand cars and fuel are both suddenly more expensive (which they are), they might look elsewhere for work. Employers might then need to offer higher wages to recruit new staff, and to make a return on their spending, they might need to put up the price of the goods they sell.
For the Bank, the worst-case scenario is a “wage-price spiral” which can only be reined in by a sharp rise in interest rates. This would make debt much more expensive, which would have consequences for the housing market (arguably not such a bad thing) and also for businesses and individuals who need to borrow money or pay their credit card bills (definitely a bad thing).
However, it may be that inflation is even more of a problem in Europe, where economies of different speeds connect under the same currency. The European Central Bank’s (ECB) own gigantic bond-buying programme has yet to begin tapering off – which is good news for Italy and Spain, where more economic stimulus is the priority, but is not so welcome in Germany, where the newspaper Bild now refers to the ECB president Christine Lagarde as “Madame Inflation”.
In fact, because most economies took the same measures to stave off financial ruin when the world came to a halt in 2020, inflation is now a global phenomenon. It may be slowed if the Omicron variant dampens economic activity for a while, but the new strain could also mean governments need to print even more money while supply chains experience yet more disruption, which would take inflation higher for longer. In that case, we may need a bitter medicine to cure it.
Find the other entries in the New Statesman A-Z of 2021 here.