The Bank of England ignored key indicators of post-Covid inflation and responded too late.

• The Bank of England ignored money supply growth early in the pandemic, enabling subsequent second-round effects in the form of a price-wage spiral to unfold.

• Had the Bank of England paid attention to second-round effects, it would not have perceived inflation as ‘transitory’.

• The Bank of England’s mistaken diagnosis of what caused inflation had delayed its policy response by six months.

• To avoid repeating the same mistakes, policymakers should focus on introducing more definitive and hardline stances on monetary policy based on new central bank models incorporating more heterodox frameworks.

The Bank of England’s failure to manage post-Covid inflation has raised concern over the credibility of Threadneedle Street’s forecasting and policy making.

New research from Leeds Policy Institute (LPI) finds that these concerns are well grounded. LPI’s new paper finds that the Bank of England's ignorance of money growth early in the pandemic made them underestimate the possibility of high ‘transitory’ inflation turning into a stubborn inflationary crisis.

“The Bank’s ignorance of money growth and subsequent failure to foresee the long term impacts of inflation that materialised in the form of second-round effects led it to believe that inflation was transitory. Had the Bank of England recognised the inflationary risks of its excessive monetary stimulus throughout the pandemic, it would have engaged in contractionary monetary policy much earlier given the risk of a steepened Phillips curve cultivating the aforementioned second-round effects.”

The paper offers a novel historical account of inflation and central bank decision-making throughout the pandemic and post-pandemic period.

“Had the Bank of England recognised that QE and high money growth enabled high demand amid supply constraints to worsen price pressures, it would have identified the risks of a steepened Phillips curve and the distributional conflict between firms and households which accelerates inflation. This would have prompted the MPC to start preemptively raising the policy rate and ceasing QE operations in May 2021 – six months earlier than the Bank of England’s actual policy decisions – to mitigate the risk of a price-wage spiral developing,” the report claims.

LPI’s Head of Research and paper author, Hubert Kucharski, said:

“Our paper comes at a crucial time. The Bernanke review provided to the Bank of England, while helpful in identifying the operational failures associated with Bank modelling, we are afraid, will fall flat on deaf ears.

“There is a difference between predicting the right trajectory with big errors and predicting the completely wrong one. As a reminder, Bank forecasts claimed the pandemic to be disinflationary, we now know these predictions were quite detached from reality.

“No improvements in the structure of models could fix this. The Bank failed to see the right trajectory of the pandemic because of their ignorance of money growth and other heterodox modelling approaches, not because of fan charts. Exposing the Bank of England’s errors through a qualitative review of monetary policy through a historical context illuminates the need for a culture change at the Bank. Without one, we are afraid that Bernanke’s contributions will leave no marked change in attitudes towards monetary policy.”

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Notes to Editors

• ‘Inflation, Money Growth and Second-Round Effects: How Effective has the Bank of England’s Monetary Policy Been?’ is the first paper to be published by the Macro Policy division at Leeds Policy Institute.

• We write our paper at a time when the Bank has received an official critique and review from Nobel Prize Laureate Ben Bernanke, but upon analysing the Bank of England’s dismal response, we find that these recommendations will fail in stoking any significant change to monetary policymaker's decisions.

• With UK inflation having reached a 41-year high, the Bank of England must learn from its mistakes correctly, and this learning process will start with a significant culture shift in the economic theories that are dominant in Bank models.

CONTACT: thinktank@luu.group / 07895 958710

A full copy of ‘Inflation, Money Growth and Second-Round Effects: How Effective has the Bank of England’s Monetary Policy Been?’ can be read here.

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About Leeds Policy Institute

Leeds Policy Institute (LPI) is a UK-based and student-led think tank affiliated with Leeds University Union (a registered UK charity). It is dedicated to undertaking empirically driven and non-partisan policy research that centres on both local and national issues.

Our 6 Policy Areas for 2023-24 are: 

• Macro Policy

• Energy and Environment

• Urban Planning and Transport

• Social Policy

• Market Interventions

• Financial Regulation

Established in April 2023, the Leeds Policy Institute (LPI) endeavours to facilitate the engagement of young individuals in ongoing policy dialogues. Through initiatives encompassing funding for informative speaker engagements, publication of student-authored articles, and collaborative delivery of skill-enhancing workshops in conjunction with the university, LPI seeks to empower its student members and contribute to the betterment of society.