Does inflation need to be tamed?

You don’t have to be an expert in medieval history to know that Western medicine in the middle ages was not particularly advanced. In many ways, it was positively barbaric and bizarre. Trepanning is one of the best examples.  It involved drilling a hole in the skull to relieve the ‘pressure’ on the patient’s brain as it was thought that this pressure which was the cause of their terrible headaches, mental illness etc.

In one way it was surprisingly effective at dealing with the condition affecting the patient.  But it usually did so by killing them.  A cure which was often far worse than the condition it was intended to address…

Since the Great Recession of 2008-12 (and beyond for some), we have seen and experienced some very strange things in the world of Economics. Things which call into question the way we understand economics and what it means to us, the ordinary men and women in the street (or on the Clapham Omnibus as lawyers might say).

One example sticks in my mind of how disorientating that period was.

At the height of the initial 2008-09 ‘market correction’ of the particular version of the free market economy we had at that time, you might recall that one investment bank suffered stock losses which its economic models indicated should only happen once every 20,000 years and these ‘black swan events’ occurred for several days in a row. As an aside that does seem pretty strong circumstantial evidence that the economic models used by that bank were possibly not fit for purpose, that is a topic for another time.

But something caught my eye over the weekend that, even by those standards, seems truly odd.  It was the recent statement by a former member of the Bank of England’s Monetary Policy Committee that the Bank was ‘duty bound’ to cause a recession in order to ‘tame’ inflation.

Now, there are a few things happening here.  The person making the claim was Adam Posen and he ceased to be part of the MPC in 2012.  He now runs the Washington thinktank ‘The Peterson Institute’ which describes itself  as “..an independent nonprofit, nonpartisan research organization dedicated to strengthening prosperity and human welfare in the global economy through expert analysis and practical policy solutions.” 

It has recently won the ‘Best Economic and Financial Affairs Think Tank’ award from Prospect magazine, which is centrist in its political economy outlook, so it let’s assume that it isn’t a home for extreme economic views.

Now, this might just be an example of a Think Tank doing what we kind of expect it to do, provocatively thinking (and saying) the ‘unthinkable’ in order to prompt us all to…well, think …..but much more creatively than perhaps we otherwise would have done about the challenges at hand.

The phrase ‘duty bound’ is also interesting.  It hints at ethics and higher purpose, as opposed to a purely technocratic role for the Bank.  That ethics and sense of higher purpose is, I am sure a motivator to many of the Bank staff, but it isn’t explicitly part of its prescribed role or functions.

The introduction of the idea that the Bank needs to ‘tame’ inflation is also provocative in that it almost positions inflation as some kind of sentient economic entity which is out of control and needs to be civilised; and implicitly implies that controlled inflation has a beneficial economic impact.  Inflation has been likened to a force for disorder or entropy in the economic system and something which helps to keep it dynamic and flexible –  if it operates within limits.  And UKHMG has told the Bank what those limits are, inflation should, over the medium to longer-term, be at or around 2% per annum.  It peaked in March at 7% and with the impact of Brexit and the war in Ukraine looks likely to be on an upward trajectory for the immediate future.

That trajectory is doubtless, what so concerns Mr Posen and many others, and they are right to be concerned about high and rising inflation.  History shows us many examples of how politically destabilising very high inflation can be.  But it also shows us how politically and societally destabilising severe recessions can be.

It is worth bearing in mind (again, harking back to the recession of 2008 onwards) that voices calling out for ‘tough love’ and ‘painful but necessary medicine’ are usually not on the receiving end of that love or medicine.

But what exactly can the Bank do about the inflationary pressures we are under given that, by its own admission, these are principally imported, i.e UK inflation is not being driven by specific aspects of the UK economy such as excessive pay rises?  How will a significant hike in Base rates or, even worse, crystallising a recession help reduce these external inflationary pressures?

We all recognise the challenges facing the UK economy, with imported inflation, post-Brexit labour shortages, continued low levels of productivity and reduced levels of foreign investment.  But to deliberately bring about recession through a material increase in base rates and that to be the desired outcome, not an ‘unfortunate by product’ may seem to many like the perfect practical illustration of using a  sledgehammer to crack a nut. It could, at worst, be the economic policy equivalent of trepanning. Economics might be about to get a lot more ‘interesting’ following this week’s Monetary Policy Committee meeting.