Don’t Let the Bank Rewrite History on What Caused Inflation

When inflation does return to target, we must avoid writing up a faulty history of this period. One self-serving narrative from policymakers maintains that the UK’s price surge was almost all driven by supply shocks from the pandemic and Ukraine war, with the Bank then cautiously managing inflation’s decline. It is a variant of the “inflation is transitory” argument of late 2021, albeit implying that the “transitory” period lasted longer than envisaged.

Unfortunately, this story is a popular misconception. Consumer prices today sit about 12 per cent higher than if inflation had remained at target since early 2020, compared to an 11 per cent equivalent excess in the US. While the UK’s price surge certainly stems less from demand-side macroeconomic stimulus than America’s, basic GDP data highlights that the Bank delivered excessive monetary stimulus here too, further fueling inflation.

In the US, total spending on final goods and services — equivalent to cash GDP — ended 2023 a striking 9 per cent above the trend experienced through the 2010s, while real output lagged 1.8 per cent behind its equivalent pre-pandemic path. Using those trends as a neutral baseline, this simple methodology implies that around 80 per cent of the overall American price level spike between 2020 and 2023 is owing to excessive spending or demand, which would have driven inflation way above target even absent the pandemic or Ukraine war.

Here in the UK, supply problems were indeed more significant. Total spending is now around 3 to 4 per cent above its pre-pandemic trend, showing that the UK also experienced excessive stimulus. Yet real output struggled more, falling 6 to 7 per cent behind its former path. In other words, sluggish growth, driven in large part by supply shocks from the pandemic, Ukraine war, and Brexit, is undoubtedly a bigger part of our inflation story than America’s.

The key point, though, is this: even if the Bank of England was right to disregard the supply shocks and not tighten policy to offset the higher prices they produced, its policy still produced about two years’ worth of additional inflation through excessively loose monetary policies. And such an assumption is extremely charitable. The Bank should really have anticipated significant growth impediments from Brexit trade barriers and pandemic supply disruptions when setting a monetary policy to hit its inflation target.

Sadly, the Bank has since been behind the curve again, albeit in the opposite direction. From last September, price increases have been below levels consistent with the 2 per cent inflation target, implying that past monetary policy was too tight. And looking at M4x money supply growth data — and considering it takes about 18 months for this to fully affect prices — suggests a real possibility of below-target inflation, or even deflation, by early 2025.

Acknowledging that the Bank of England was an inflation arsonist rather than firefighter during that price surge is crucially important. As I document in a new book, The War on Prices, the notion that this high inflation was solely driven by one-off shocks or malevolent actors, not central banks, is a widely held view that risks a toxic legacy for policy.

This misconception led various governments to demand voluntary pricing restraint from businesses and workers, encouraged myths about “greedflation” and led to some damaging price controls. Given none of these could alter the macroeconomic fundamentals, they didn’t quell inflation. Yet they did induce misplaced anger and economic inefficiency, while eroding public confidence that central banks even have the power to control inflation.