The excellent Richard Jeffrey, Chief Economist at Cazenove Capital, makes a good point in his latest newsletter (available only to clients, sadly). The Monetary Policy Committee, he notes, now estimates that UK economic growth during 2011 will be about 1.5% – markedly less than the 2.6% it was predicting just a year ago. Meanwhile, the MPC's forecast for inflation is now 4.8%, considerably higher than the 3.3% that it predicted just a year ago. "If the MPC's short term expectations are so unstable and prone to error," says Jeffrey, "the basis on which shifts in monetary policy are made must be called into question."
Quite. The Bank of England has just 'printed' another £75bn of new money – around 5% of GDP – to try to stimulate growth, on top of the £200bn it has already conjured up. A total stimulus of nearly 20% of GDP is a big stimulus indeed. As Milton Friedman never tired of telling us, monetary policy is a very powerful and brute tool, and an expansion on this scale in such a short time is brute indeed. If it is being made on the basis of flaky figures, that makes it even more worrying.
There are two reasons why things in the UK look so bad (and why firms are battening down rather than investing and expanding – as the latest unemployment figures show all too clearly). First, incomes are not growing fast: some people have taken pay cuts, in fact, while others have lost their jobs entirely. That is what you expect in a recession, if you are a Mises fan, at least: after the fake, credit-fuelled binge of the last decade and a half, the inevitable hangover is painful but inevitable.
The other reason is that inflation is eating into what pay rises people are getting, leaving them generally worse off. And (Friedman again) you can put that down to monetary policy. Like anything else, creating too much of the stuff just makes it worthless, and the MPC has created too much of the stuff. If overseas investors come to the same conclusion and sterling becomes devalued even further, the prices of many essential imports like food and fuel will rise even more, and UK consumers will feel themselves even worse off.
The solution? Hayek this time: inflation must be stopped dead. It is corrosive, and it stops markets from working properly. And if you want to get out of a recession, you need your markets to work as well as you can possibly make them. On that front, high taxes and bad regulations are bad enough, but inflation is a disaster. Present policies may just make things worse, rather than better.