According to Jonathan Haskel, the Bank of England is full of “arch-monetarists”. It’s a reference to an embattled school of economic thinking that says the money supply determines the level of inflation in an economy. Yet for Haskel, an external ratesetter on the Bank’s monetary policy committee, the tag seems ill-fitting.
His academic work focuses on how to lift Britain’s chronically low productivity by channelling investment into modern growth drivers such as research, software and patents, but nevertheless he thinks “we are all arch-monetarists in this building because we spend our entire time worrying about the interest rate and the interest rate curve. There is a mapping between interest rates and the money supply.”
His comments come after sustained criticism from some quarters that the Bank has paid insufficient attention to the growth in the money supply over the past decade, one of the reasons it allegedly was too slow to crack the whip on inflationary pressures after 2021. This critique was given voice in a report from the House of Lords this week, which suggested that the absence of a monetarist economist on the MPC was part of a broader lack of “intellectual diversity” at the Bank. Stephen King, a senior economic adviser to HSBC, told the Lords that the MPC had ignored money supply “in a rather foolish fashion”.
The Bank’s quarterly Monetary Policy Report seems to have heeded the pressure and recently began to publish measures of the money supply (or “aggregate money”) in its 250-page assessment of the economy.
Haskel denies the charge of groupthink, but also casts doubt on the monetarist philosophy that was in vogue during the inflationary explosion of the 1970s. He questions whether broad measures of money provide ratesetters with any “additional information” about inflation, compared with the state of borrowing costs. Instead, more specific indicators such as credit growth are better proxies for future price pressures.
“If you ask a small business, ‘What do you think of the money supply?’, they will look at you like you’re from Mars. If you ask a small business about the availability of credit, which is regularly what we do, that is much more useful to monitor the state of economic activity than just the money supply.”
Monetarists who fretted about the upswing in the money supply after the Bank’s quantitative easing programme in 2009 are concerned now about the sharp contraction in money measures since late last year, a phenomenon that they think will lead to rapid disinflation and will require interest rate cuts after aggressive tightening over the past 18 months.
Haskel’s voting pattern indicates he does not share their analysis. He has opted for more aggressive monetary action at the Bank’s past three meetings, most recently voting for a 0.25 percentage-point increase to the base rate, which has been held steady since September. Last year he wanted larger 0.5 percentage-point increases at four MPC meetings, where he was outvoted by a majority on the nine-strong committee.
His relative hawkishness is driven by fears that Britain’s inflationary headache will not be vanquished until there has been a notable cooling in the labour market. This week he delivered a speech at the University of Warwick, in which he warned: “Rates will have to be held higher and longer than many seem to be expecting.”
Haskel, who splits his time between the MPC and teaching at Imperial College Business school, said: “In 2018 when I first joined the MPC I was voting for rate cuts when all voted to stay put. I was worried the economy was going to get stuck in a bad equilibrium after the Brexit referendum, when we had endless discussions about a hard or soft Brexit. Investment completely stopped in its tracks and the economy was run down. The reason I am voting to increase rates now is the same: I don’t want the economy to get stuck in the bad situation of embedded inflation.”
He notes that Britain is still suffering from “the worst of two stresses”: a European energy price shock that drove inflation to multi-decade highs in most continental countries last year; and a red-hot American labour market.
His warning comes after consumer prices inflation registered its single biggest month-on-month drop in more than a decade in October, declining from 6.8 per cent to 4.6 per cent, the weakest reading in two years. He and his fellow ratesetters, though, are paying more attention to granular measures of inflation, such as wages and inflation in the services sector, to get a better sense of where prices could be heading over the next three years. That is because the annual measure of inflation is distorted by last year’s gas price rise falling out of the inflation calculation.
When making his monetary policy judgments, Haskel is putting greater emphasis on the number of open job vacancies relative to the number of unemployed people in the UK, to assess what could happen to wages in the coming year. The vacancy ratio, which shot up to a record last year, could explain why workers have been able to negotiate better pay deals from employers who are otherwise struggling to fill jobs. Private sector earnings growth has been stuck above 8 per cent in the past six months and the number of unfilled vacancies shot to a record of 1.3 million last summer, dropping gradually to just under a million in September.
The sheer number of unfilled jobs is one of the peculiarities of the UK’s labour market after the pandemic, which has meant that the highest interest rates since 2008 have not resulted in the mass layoffs that economics textbooks would predict. Economists have posited that rather than firing workers, companies have responded to tighter monetary conditions by reducing their demand for new employees.
This seems to be borne out by Britain’s relatively low unemployment rate over the past two years, with a recent rise in the jobless rate to 4.2 per cent still modest by historical standards. The United States has undergone a similar dynamic, raising the odds of a “soft landing” in the world’s largest economy.
Haskel argues that the vacancy rate is more helpful than “traditional measures of labour market slack, like unemployment”. It is the slow rate of decline in vacancies that leads him to think that wage growth will remain stubbornly high and could necessitate a strong monetary policy response. The MPC’s final meeting of the year is on December 14 and traders are expecting the base rate to remain unchanged at 5.25 per cent.
For all his worries about stubborn inflation today, Haskel does not think the Bank was caught out in 2021-22 and maintains that the inflationary shocks in the pandemic period were transitory, a much-pilloried term in central bank parlance today. He insists that the Bank was right to think that supply chain constraints and an initial energy cost climb in mid-2021 would fade within a year. The problem was a “shock after shock after shock” prompted by Russia’s invasion of Ukraine that resulted in a sustained price growth.
Haskel’s calculations suggest that energy and food price costs will fade in the coming quarters, “leaving the relatively tight labour market the medium-term determinant of what’s going to happen to inflation”. He admits that the Bank, like most of its peers, does not have a forecasting model that can account for “extreme events’, such as the near-300 per cent surge in natural gas prices in Europe last summer. He also says the Bank had no idea what the end of the government’s furlough scheme in September 2021 would mean for the million people on retained jobs, and chose not to raise rates the following November because of the uncertainty.
These judgment calls are likely to be the subject of a forthcoming independent review of the Bank’s forecasting errors carried out by Ben Bernanke, the former US Federal Reserve chairman who has been at Threadneedle Street for the past month. Bernanke’s report is also expected to recommend ways to improve the Bank’s communication after two years in which it has been under heavy fire from politicians, the media and financial markets. Haskel believes that the Bank’s “narrative has been the right one, but maybe we need to work harder”.
