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The next big economic shock

At the latest meeting of the IEA Shadow Monetary Policy Committee, Graeme Leach voted to begin reversing QE in 2021Q2 as a result of the surge in broad money supply growth in 2020 and the resulting threat of a sharp rise in inflation later this year and next.

The latest 12 month inflation rate on the CPIH measure fell to 0.6 percent in November from 0.9 percent in October. Lockdown induced falls in output mean that the UK economy is likely to be now back in recession with two quarters of successive negative quarterly growth in 2020Q4 and 2021Q1. Combined with the risk of a spike in unemployment in 2021Q2, following the end of the furlough, this is not the backdrop against which one would expect rising inflationary pressure. However, the inflationary pressures in the system are greater than at any point since the death of inflation in the 1990s. The cause of the soon to be seen resurrection of inflation, in late 2021 and then into 2022, is the surge in broad money supply growth in the UK. Latest figures for the Bank of England's M4x measure of the broad money supply show a 12 month growth rate of 14 percent in November.

Broad money growth of this order of magnitude suggests double digit growth in nominal GDP at a time of weak real GDP growth - the gap is inflation. Even allowing for a post lockdown, successful vaccination programme impetus to the economy, money growth on this scale will inevitably flow into rising inflation, albeit with a lag. The UK of course is not alone in this monetary surge. 2020 saw record peacetime growth in the broad money supply in the US, and an acceleration in the Euro-zone and Japan also. Thus far the monetary stimulus has found an outlet in asset and commodity prices, with the feed through to goods and services inflation likely to be the dominant economic story later this year and next.

The resurrection of inflation is likely to be encouraged also by the nature of the post-Covid 19 economy. The UK household savings ratio was around 8 percent at the end of 2019, before exploding to 27 percent in the 2020Q2 and falling back to 17 percent in 2020Q3. The second and third lockdowns at the very least will have only permitted a moderate further reduction, and it is quite possible that the 2020Q4 figure, when published, could show no fall or a rise even. This suggests there is a 'wall of money' which could be drawn on later this year. Off course, there are no certainties here. Some continuation of consumer caution and saving for a rainy day - e.g. a mutation of the virus against which current vaccines are less effective - might be expected to prevail, at least in part. A degree of consumer caution is also likely to be encouraged by the ending of the furlough.

Notwithstanding these influences however, the big story later this year and in 2022 will surely be the resurrection of inflation as too much money chases too few goods and services.