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

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The 2020s have demonstrated, yet again, that inflation is always and everywhere a monetary phenomenon. After the Bank of England overreacted to the Covid-19 pandemic in spring 2020 with needlessly large asset purchases, the increase in the quantity of money (on the M4x measure which the Bank itself favours) reached 15 per cent in February 2021.

Although many people seem to be baffled by the processes which connect money and the price level, double-digit inflation became very likely.

Somewhat absurdly, the Governor of the Bank of England has denied that money was relevant to the recent inflation episode. Andrew Bailey used a recent speech — to fellow central bankers, at a get-together in Jackson Hole, Wyoming — to blame it on the Ukraine war and other alleged shocks from abroad. This is wrong.

In February 2022, before the Ukraine war and any of the shocks Bailey identified, the annual increase in the consumer price index was already 6.2 per cent, more than treble the target of 2 per cent. It had risen from an exactly on-target 2 per cent number reported in June 2021, only seven months earlier.

Sure enough, the Ukraine war then did affect the numbers. The annual CPI increase reached 10.1 per cent in July 2022, and stayed close to or above the 10 per cent mark until April 2023.

Anyhow, from spring 2022 the Bank realised that its main task was to reduce inflation. Whatever its Governor may have been thinking or saying about the matter, it took decisions which did have the effect of checking money growth.

Whereas in the two years to February 2022, M4x climbed by almost 21 per cent, in the two years to February 2024 it went up a tiny 2.2 per cent. And, lo and behold, after a similar lag to that between the money acceleration and the inflation take-off, inflation has dropped back towards the target figure.

Many economists remain worried that wages have been going up too quickly

The better inflation news is of course welcome. However, many economists remain worried that wages have been going up too quickly to be consistent indefinitely with 2 per cent inflation.

As productivity growth is now so low, annual wage increases need to be only 3 or 4 per cent for that sort of inflation to be sustained. The latest data show that earnings are up by 5.5 per cent in the last year. On that basis, pay inflation is still too high, although not dramatically so.

In the 2020s the monetarists have therefore been right to insist that inflation is a monetary phenomenon. But they have perhaps not been entirely frank about a major weakness in their arguments. The problem arises from two features of any attempt to combat inflation by monetary means.

The first is that clamping down on money is effective only because it hurts; very slow growth in the quantity of money hits asset prices and balance sheets, and hence curbs spending and raises unemployment.

Happily, in the current cycle the return to target has not required a severe recession. (But note that late 2023 did see two successive quarters of falling output and in that sense Britain did suffer a so-called “technical recession”.)

The second point is less noticed, but very important, not least because of its considerable political significance in a nation like Britain. Monetary policy works only in the private sector. As every agent in the private sector can go bust, credit-worthiness is finite. Because a company cannot borrow indefinitely to pay its bills, it must have some money balances to stay in business.

By contrast, the state has a monopoly of the legitimate use of force, and in principle its power to extract resources — by taxing or printing legal tender money — has no check.

In other words, the government’s credit-worthiness is limitless within its own borders. As a result, its money balances are tiny relative to its expenditure. Controlling the quantity of money does not affect the government, and restraining inflation in the public sector is very different from restraining it in the private sector.

In the private sector, millions of companies are subject to competition from market forces, and chief executives and finance directors are constantly alert to the latest bank statement. In the public sector only one buyer (the government itself) confronts teachers and university lecturers in the education sector, doctors and nurses in the NHS and so on, and these workers belong to a public sector union which tries to act as one seller.

In the 40 or so years after the Second World War, the UK was a unitary state with a highly centralised system of government, and a large public sector. Employment in the public sector was a quarter of the total. Today the figure is somewhat lower because of Thatcher’s privatisations, but it is still about 18 per cent.

Moreover, we have a Labour government with a big majority, where — according to the Daily Mail — more than half of its MPs have taken donations from the unions since the general election was called. Will public sector inflation now run consistently ahead of that in the private sector? And how will the Bank of England react if it does?