What kind of world do we live in today?
From an economists’ view, one that’s a lot different from just a handful of years ago.
War in Europe. Strained global trade. Government debt stocks at multi decade highs (certainly in the UK). All fixtures of our present day lives.
But there’s two things that have shifted the economic goalposts: higher inflation and interest rates.
The former has been on a real tear for more than a year. It has plagued family finances, raided businesses’ balance sheets and triggered huge interventions from governments.
For Stephen King, senior economic adviser to Britain’s largest bank HSBC and boasting a long CV of top policymaking and research roles, the return of inflation has drawn central bankers – those tasked with keeping prices steady – into an uncertain world.
“Inflation appeared to be dead and buried for many decades. No one was interested in it at all,” he told City A.M. high up HSBC’s Canary Wharf offices.
“You could arguably define price stability as a world where people just aren’t talking about inflation. It’s just not part of the average dinner conversation,” he said.
In Britain, families have devoted hours to discussions on whether to keep the heating on or how much to spend on the weekly shop for some time now.
Prices in Britain have jumped 10.1 per cent over the last year after peaking at a 11.1 per cent increase in October. Multi decade high inflation rates were reached in the US, Europe and, well, pretty much the world over in 2022.
Those lofty levels came after the likes of the Bank of England, Federal Reserve and European Central Bank told the public that inflation would be “transitory”. After months of persistence, King wasn’t buying it.
“I just thought this doesn’t feel like the sort of thing we were used to… It requires a story to be told.”
King has just published his fourth book, We Need To Talk About Inflation, in which he draws on some of history’s most notorious bouts of inflation to yield 14 lessons, a sort of playbook on how to keep prices stable.
One point King repeats throughout the book is that fiscal policy (government tax and spending decisions) and monetary policy (central banks’ interest rate decisions) cannot be separated, something he defines as the “Burton-Taylor” law.
He is referring to the 1960s Hollywood on-again-off-again power couple Richard Burton and Elizabeth Taylor, who divorced and married twice.
Taylor always maintained Burton was the love of her life. She was buried alongside his last ever letter to her.
King’s point is that monetary and fiscal policy are forever tied.
And he points out that policymakers have partly forgotten that relationship in recent years, most apparent in central banks’ massive bond buying programmes – or quantitative easing – since the 2008 financial crisis.
“I don’t think it was anyone’s intention to create inflation by adopting quantitative easing. I think it is possible to suggest that QE has made the management of inflation more difficult than would otherwise have been the case,” he said.
“QE is a way in which the central bank nationalises the government’s bond market, and that in turn means that the yields on government bonds can’t necessarily move to anticipate higher rates of inflation.”
“This is the equivalent of removing your radar system before an enemy bombing.”
Just last autumn the gilt markets showed how powerful they can be. They effectively made Liz Truss the shortest serving Prime Minister ever, spitting out her ill-fated mini-budget by forcing debt rates higher.
Normally, when debt rates rise, it strengthens a country’s currency by making said country’s assets more appealing. The pound hit a record low against the US dollar shortly after that not-so-mini-budget.
But King in his book is more occupied with monetary rather than fiscal policy, using the lessons from the past to scrutinise the Bank of England, Federal Reserve and, to a lesser extent, European Central Bank’s roles in letting inflation get out of hand.
The series of tough interest rate rises over the past year have been in part an attempt to “recapture some of the credibility that they thought they had, which has proved to be a little more difficult to maintain more recently”.
Public perceptions matter. If people don’t think a central bank is willing or able to tame inflation, then there’s no rational reason for them to believe it will stabilise.
If central banks take “people’s attitudes as a given that they never change, then there’s a significant danger of making a policy error,” King stressed.
The big question now is when will inflation finally drop back to two per cent?
Families in Britain, America, Europe and across much of the world are worried about higher living costs sticking around.
“Once [they’re] established… it becomes a political and social problem because inflation is an incredibly arbitrary way of creating winners and losers within the society,” King said.
“In that sense, it’s profoundly undemocratic.”