This article is taken from the December-January 2024 issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering five issues for just £10.

Has the old lady of Threadneedle Street lost her marbles? Can the Bank of England still do anything right?

In its first 25 years of independence from the Treasury and the politicians it delivered an inflation rate which, on average, was exactly on the 2 per cent target. Admittedly, inflation had its ups and downs, and the Great Recession of 2008 and 2009 was a blot on the escutcheon. All the same, for a generation it was widely admired and respected as an efficient part of the British economic constitution.

But in the last few years much has gone wrong. In 2020 it embarked on large-scale asset purchases to counter the assumed deflationary effects of the Covid epidemic. This was a misjudgement which caused the rate of money growth to soar into the double digits and to reach the highest levels for 40 years.

Milton Friedman, the most celebrated modern champion of the quantity theory of money (a.k.a. “monetarism”), once said that inflation followed money after a lag of about two years. Sure enough, by summer 2022 UK consumer inflation was in double digits.

For the time being the bank is still focused on bringing inflation back to target. Regardless of evidence, its senior officials have routinely denied that the monetary excesses of 2020 and 2021 were responsible for the inflation overshoot of 2022 and 2023. They continue to ignore the behaviour of the quantity of money, in the apparent belief that money aggregates do not matter to anything.

In an April 2023 speech Professor Sylvana Tenreyro, then a member of the Monetary Policy Committee, said that monetary policy was exclusively about interest rates and bond yields, and that the quantity of money had no independent impact on the economy.

The story is now changing. Unhappily, monetary policy has lurched from inflationary excess to deflationary overkill. Whereas in 2020 and 2021 the Bank of England kept interest rates at zero and bought government bonds on a massive scale, since early 2022 it has raised interest rates to over 5 per cent and sold government bonds in even larger amounts.

The quantity of money is falling. In the year to September the most closely watched money aggregate — known as M4x broad money to its fans (which include me) — went down by 4.2 per cent.

Whatever its problems, the Bank of England is good at preparing statistics about Britain’s economic history. Its website provides a magnificent dataset — a “millennium of data”, no less — which no other central bank can begin to match.

One insight from the information is that the UK has only once recorded a larger fall in broad money, in 1921 and 1922. What happened to the economy at that time? 1921 saw the biggest-ever fall, of about 10 per cent, in national output.

Of course, much has changed in the British economy in the century since the slump that followed the First World War. Mechanical extrapolations would be foolhardy. All the same, the current money contraction is worrying, not least because it has been accompanied by a steep drop in small company share prices, weakness in the housing market and other tell-tale signs of an impending cyclical setback. Friedman’s hypothesis of a two-year lag between money and inflation was a response to the long runs of United States data. He also said that changes in money affected output with a shorter lag, typically of s ix months to a year.

No one knows the exact timing of the next general election, but a date in autumn 2024 would be roughly a year from today. If the election takes place while the economy is in recession, the 2019–24 Conservative government will have been accompanied by both the highest inflation for 40 years and the rises in unemployment associated with every significant economic downturn. It would be a miracle if the Conservatives then secured re-election.

Some observers may claim that the Covid epidemic caused much of the trouble. But others will blame the Bank of England, not least because the UK’s pattern of boom and bust has been worse than in other Covid-affected nations. If so, the Conservatives in opposition will undoubtedly review the Bank of England’s constitutional status and, in particular, may suggest that the benefits of its independence have been overstated.

There would indeed be something question-begging and unsatisfactory if the Bank of England suddenly in 2025, under a Labour government, restores a better economy with on-target inflation.

The truth is that the independence of its central bank is neither necessary nor sufficient for a nation to enjoy steady growth of output with stable prices. The central bank’s top economists may believe in false theories and be incompetent in interpreting the latest macroeconomic numbers.

Like the Bank of England in the 2020s, they may make mistake after mistake. The monetarists have proposed that stable growth of the quantity of money, at the appropriately low rate, is necessary and sufficient for macroeconomic success. They have certainly had the better of the argument in the last few years.