Debate: Should the Bank of England tighten monetary policy?

Julian Jessop and Tom Spencer

November 12, 2021

Julian Jessop, independent economist and IEA economics fellow, argues YES

Monetary policy is too loose and needs to be tightened to protect living standards and for the long-term health of the economy.

For a start, it is no longer necessary to keep UK interest rates at the emergency low of just 0.1 per cent. The latest data show that GDP was just 0.6 per cent below its pre-Covid level in September, and more timely business and retail surveys show that the economic recovery is regaining momentum.

We are also well past the point where the pick up in inflation can be dismissed as ‘transitory’. The temporary price pressures all seem to have been larger and longer-lasting than expected. As time goes by, they are ever more likely to become embedded in the economy as decision-makers take higher inflation for granted.

The greater threat to ‘strong, sustainable and balanced growth’ is therefore now a sustained period of high inflation, not a shortfall in demand. This is why the Bank of England’s Monetary Policy Committee has ‘judged that some modest tightening of monetary policy over the forecast period was likely to be necessary to meet the 2 per cent inflation target sustainably in the medium term’.

This would not be an economic disaster – but should help to prevent one. The Bank of England would simply be taking the foot off the accelerator. Interest rates and borrowing costs are likely to remain near historic lows – especially real rates, after allowing for inflation. With other central banks responding in similar ways, the risk of a surge in the value of sterling is small.

My own best guess is that the Bank of England will end money printing and raise short-term rates to 0.75 per cent in 2022, which would only take them back to where they were in 2019. That would signal that the Bank is serious about keeping inflation down over the medium term, which is, after all, its main job.

Tom Spencer, Chief Organiser at London New Liberals, argues NO

Typically, we think the role of the Bank of England is to ensure inflation is low and stable. What we often forget is that it’s also supposed to ensure ‘strong, sustainable and balanced growth’. Tightening the money supply right now, either by selling long term bonds or increasing the bank rate, would directly undermine the latter of those targets.

The purpose behind both of these is to increase what economists call the real interest rate — that’s the actual cost a debtor pays for loans, and the actual yield their creditor receives. The logic behind tightening is that by making it harder for people to take out loans you can reduce inflation.

Of course, the costs of inflation can be harmful, but it is essential to remember that there are two types of inflation: transitory and permanent. Transitory inflation occurs when there’s a disequilibrium in the economy; it can normally be solved through market forces. Permanent inflation is much more problematic. It occurs when inflation is embedded in market equilibrium, or in economist terms, when nominal income is growing greater than capacity.

Inflation right now is driven primarily by supply chain issues and an energy shortage. Rising rates won’t eliminate these issues – but, it will slow down the wider real economy which is still suffering from the impacts of the pandemic. There is not yet a good reason to trample our recovery to protect against inflation we know will be temporary. Till there is, the Bank must resist calls from hawks to tighten.


Written by Julian Jessop and Tom Spencer

Julian Jessop is an independent economist and economics fellow at the IEA. Tom Spencer is Chief Organiser at London New Liberals.

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