A further look at the causes and solutions for inflation
Costas Lapavitsas is Professor of Economics at the School of Oriental and African Studies andconvenor at European Research Network on Social and Economic Policy
Doug Nicholls is General Secretary at the General Federation of Trade Unions
James Meadway is Director of the Progressive Economy Forum
This is an excerpt from the pamphlet The True Causes of Inflation: Weak Production and
High Profits. You can read the entire pamphlet HERE
There are economists and others who will try to explain persistently high
inflation by claiming that there is “too much money” in the economy. They are
usually known as Monetarists, or supporters of the Quantity Theory of Money,
who were very influential in Margaret Thatcher’s governments. For working
people today this view would immediately sound odd – the problem right now for
most of us is the exact opposite. Prices are too high, and we do not have enough
money. “Too much money” would be a problem that most people would dearly
love to have.
Nonetheless, for some politicians in the Conservative Party, this is the preferred
explanation. Tories, such as former Cabinet minister Iain Duncan Smith, have
blamed the Bank of England for “printing huge sums of money” (in Duncan
Smith’s words) with “Quantitative Easing” (QE). The BBC quoted former Tory
leadership contender Tom Tugendhat saying:
“…what’s triggering inflation is the lack of sound money… we have not been
tough enough on the money supply.
“I’m afraid the quantitative easing that has been pumping up the economy
and inflating a sugar high… and it’s triggering this inflation.”
Thatcherite thinktanks, for instance, the Institute of Economic Affairs (IEA), make
the same point. They are wrong, but it is important to go through the reasons why.
Quantitative Easing is the programme implemented by the Bank of England since
early 2009 to create very substantial amounts of new money electronically.
Originally, this was done by the Bank in response to the global crisis of 2007-9, which hit the financial sector very hard, with the idea being to support the wider economy by making sure there was plenty of money available to banks and enterprises at low interest rates. The Bank ran the programme again in 2012 and 2016, and then again, on a huge scale, as Covid-19 hit the British economy in early 2020.
QE works by relying on many large financial institutions (especially commercial
banks) holding their own accounts with the Bank of England, which they use as
their “reserves” – something like their own emergency savings accounts. When
the Bank of England operates its QE programme, it puts more electronic money
into these reserve accounts. In return, the Bank of England takes financial assets
from those financial institutions worth the same amount.
In simple terms, the Bank of England buys bonds (mostly public but also private)
from banks and beefs up the accounts the banks hold with it. The outcome is to
introduce a huge amount of newly created money into the financial system. This
was £200bn by the end of 2009, with smaller increases over the rest of the
decade. But by the end of 2020 the total amount of new money pumped into the
financial system was £895bn, as the graph below shows.
This is, obviously, a huge amount of money. It is, for instance, nearly five times
the entire budget of the NHS for 2021-22, or almost five twenty times the budget
for the Defence Forces for the same year. But what matters for inflation is what
happens to the money.
For the supporters of free markets and Monetarists, the idea that creating more
money automatically leads to inflation is a very old one. Milton Friedman, one of
the architects of the turn to free market capitalism in the 1970s and 1980s and
leading Monetarist, argued in the 1960s that “inflation is always and everywhere a
monetary phenomenon”. He meant that if inflation was happening, it could
always be explained by changes in the amount of money in the economy.
When free market supporters today claim that QE leads to inflation, they are
trying to make the same point. Their argument is that, if more money is put into
the economy, unless there also a growth in the number of things to buy, this new
money will automatically lead to price rises. There will be more money chasing
the same number of goods and services and so (the theory goes) people
supplying the goods and services will have an incentive to put up their prices to
obtain some of that extra money now circulating in the economy.
But the argument does not stand up as far as general inflation is concerned.
There is no obvious link between QE, which has been used since April 2009, and
general inflation, as the graph below shows. Since QE started in early 2009,
inflation has repeatedly fallen to very low levels, even turning negative in May
2016. For significant periods of time, prices were falling, despite the new QE
money in the economy.
On the other hand, QE has led to some, very specific, price increases. By creating
new money and handing it to major financial institutions, the Bank of England
has helped push up the price of financial and property assets. This happened
because those financial institutions took the newly created money and used it to
trade in financial assets (such as shares) and real estate. As a result, share prices
and, especially, property prices in Britain were consistently pushed up, even as
the rest of the economy suffered during covid. Rising share prices and, even more, rising property prices and rents represent increases in financial wealth. So, while the supply side of the British economy was
being run down and in stagnation in the 2010s, and there was the rise of zero
hours contracts and the casualised gig economy worsening the incomes of the
majority, QE directly contributed to even greater wealth inequality. The worst
aspect of it is that, by increasing wealth inequality, QE made it even harder for
first-time buyers, especially in the large urban centres, to buy a home.
But there was no obvious link between QE and inflation during the last decade. The important point for current inflation is that in the pandemic the impact of QE shifted. The exceptional government spending during 2020, including furlough and exceptional support for enterprises, was paid to a large extent
through QE. To be more precise, the government spent more and borrowed to fund the expenditure. A large part of the new debt was bought by the Bank of England, and so a part of government spending was, in effect, financed by creating new QE money.
At the same time, the government encouraged banks to lend more, often by
guaranteeing enterprise debt, and so banks increased their lending and created
even more money. The control by private banks over personal and national debt
is a key feature of the rigged economy that encourages prices and profits to
spiral. Some of the additional money created by QE, then, went into the
productive part of the economy, for example, the £70bn of furlough payments
going directly to households.
Because economic activity was deliberately suppressed by lockdown, with
consumer spending falling rapidly and millions deliberately kept from working,
this additional government spending simply replaced lost household and
replenished business income. Much of it was turned into savings held by
somewhat better-off households – household savings shot up to unprecedented
levels over 2020 and into 2021. The ONS estimate that households saved £140bn
extra during the lockdowns. These savings are now providing a cushion for
many households in the face of rising prices. But they are not causing prices to
To sum up, inflation today is not the result of more money being produced. QE
has been used for over a decade in Britain with no obvious impact on inflation.
When it was cranked up again during the pandemic, it acted to compensate for
the dramatic collapse in demand and incomes that lockdowns started to
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