The Bank of England (BoE) should stop selling bonds unless the sales will have an important influence on inflation, a report said.
Conservative former minister Sir John Redwood, who authored the report, said the Treasury should share some responsibility for controlling inflation while the BoE should be given another target for economic growth.
The MP for Wokingham said the bank must review its forecasting and models, and the bank bosses’ salaries should be tied to how well they do their jobs.
However, the BoE isn’t the only target of Sir John’s criticism. The U.S. Federal Reserve (Fed) and the European Central Bank (ECB) were also blamed for inflation in the United States and Europe.
Since the 2008 financial crisis, central banks including the BoE, the Fed, and the ECB have all adopted quantitative easing (QE), or bond purchasing, as a tool to cut interest rates, create money supply, and stimulate economic growth by driving up lending.
During the COVID-19 pandemic and the lockdowns, the central banks have further ramped up their QE programmes, with the BoE injecting £450 billion ($546 billion) into the British economy.
The amount of the additional money supply snowballs as it goes through the economy.
According to the IEA report, between January 2020 and autumn 2022, the UK’s money supply rose by 27 percent, from £2.9 trillion ($3.5 trillion) to a peak of £3.7 trillion ($4.5 trillion).
During similar periods, the ECB took Euro area money up by a quarter, from €12.5 trillion ($13.15 trillion) to a peak of €15.5 trillion ($16.3 trillion), while the Fed inflated the amount of U.S. dollars by around 40 percent, from a little over $15 trillion to a peak of nearly $22 trillion, the report said.
The pent-up demand and the supply shock during lockdowns and the Russian invasion of Ukraine means the extra money has been chasing a limited amount of goods and services, causing inflation to surge.
In 2022, the annual inflation rate in the UK hit 7.9 percent while the rate was 8 percent in the United States and 8.3 percent in the Euro area, well above their targets of around 2 percent.
Sir John said the “excessive inflation” in the three economies was “primarily due to bad errors by their central banks.”
“Deliberately inflating asset prices through QE to offset the effects of lockdowns, these banks continued with excessive monetary expansion throughout 2021 leading to high inflation in 2022 as the extra money moved beyond the inflated asset markets for bonds, shares, and property into buying goods and services and expanding bank credit,” the report said.
“The central banks persisted with forecasting low inflation until it was high and then forecast transitory inflation when it was setting in and spreading to wages and services,” it said.
Bad Modelling
Central banks rely on forecasts to inform their monetary policies as they take a long time to take effect. Sir John blamed the banks’ bad modelling for their errors in judgement.“Their models do not take the issues of money growth and credit seriously,” he said, “The Fed and BoE do not report on money growth and discuss what it means for the economy and for policy. They prefer to concentrate on the concept of capacity, seeking to judge whether the economy is running hot or cold and whether interest rates need to promote more output and employment to take up the slack or less to cool the markets.”
However, the banks tend to use labour market figures as proxies for capacity, ignoring other factors in the production supply chain, the report said.
Sir John also said the banks “tend to have a national rather than global view of capacity” while in reality, the ability to import is also a factor but is difficult to model.
Although his report analysed the monetary policies of the BoE, the Fed, and the ECB, the British MP said he’s only in the position to make recommendations for the BoE and the UK government.
He said the UK government should ask the BoE to review and tinker with its models, especially for inflation.
“The BoE should produce an analysis of the role of money and credit in inflation and discuss how this can be monitored and used to help make policy decisions about rates and money creation going forward,” he said.
Sir John also recommended the bank recruit senior staff with a diverse range of views and reward them when the bank “hits targets for accuracy of forecasts and success of outturns in policy decisions.”
BoE Selling Bonds at a Loss
During the first year of its QT process, the BoE set a target of selling £80 billion ($97 billion) worth of bonds. Last week, the bank said it plans to accelerate the process, selling £100 billion ($121 billion) in bonds in the next twelve months.However, Sir John questioned why the banks have been selling bonds when the prices were much lower than they were when they bought them.
“There are various official calculations of the possible losses, with the UK sure to lose more than £100 billion [$121 billion] on bond holdings and the ECB and Fed proportionately more given the much larger sizes of their portfolios. It is a curious thing to have wanted to do,” the report says.
While the Fed is simply not worried about losing money, “the BoE was so worried about the likelihood of large losses trashing its balance sheet that it made taxpayers and the Treasury agree to repay every pound they lost to preserve the bank’s capital,” the report said.
Sir John said the BoE should “reconsider its attitude” towards QT and stop selling bonds before they mature.
“If it is unimportant as an influence on inflation, as it says, and the purpose is technical or tidying up, it should stop selling bonds and let maturities gradually reduce its balance sheet,” he said.
“It should consider whether its bond sales do depress markets in ways that can disrupt them, consider the flow across to its tasks in maintaining banking sector stability, and ask whether too many bond sales might make a recession more likely.”
