I’ll then circle back and discuss briefly the behaviour of the demand for broad money. Page 18  The demand for central bank money. In March 2020, when the world was struck by the pandemic, there were violent moves in prices of financial assets, volatility rose sharply and market liquidity – the preparedness of financial institutions to provide short-term credit – dried up. In order to meet margin calls on derivative positions many investment firms were required to sell even safe assets (government debt). Whatever the underlying vulnerabilities that fed it, this “dash for cash” can be thought of in this context as a sharp increase in the demand for central bank money[10] – in Chart 9, a rightwards shift in the MD line. Though the particular circumstances were different each time I think you can characterise the conditions in early 2009, and again during the LDI crisis last October, in a similar manner. Meeting such demand – matching the rightwards jump in MD with a similar shift in MS – is not monetary easing: it’s the forestalling of a market-induced tightening of monetary conditions. Without that matching supply, bond yields would rise, asset prices would fall and aggregate demand and inflation would weaken (in the IS-LM model, an unmet rise in the demand for money pushes the “LM” curve to the left). And it’s one reason why, in the data, you’d expect – at least occasionally – to see shifts in central bank money that are not then followed by stronger demand and inflation[11].
They inevitably reduce real national income  Chart 16: Monetary policy cannot offset the fall in real incomes caused by a terms of trade shock  Page 27 Sources: ONS, Bank of England, Bloomberg Finance L.P. and Bank calculations. Nominal wages in the chart are private sector regular pay. It’s interesting too to ask what the world might now look like had this very steep path for interest rates been taken – but without any subsequent rise in import prices. The outcome of this experiment is the ‘alternative variant’ line in Chart 17. The predicted result – this despite the prior growth in household deposits – is a steep fall in inflation, well into negative territory. All this makes it a challenge, I think, to argue that the rise in broad money in 2020 is the main (or even an important) contributor to the inflation that’s followed. Chart 17: In the absence of big rises in import prices tighter policy would have pushed inflation into negative territory  Sources: ONS, Bank of England, Bloomberg Finance L.P. and Bank calculations. The ‘alternative variant’ reflects the same monetary tightening imparted in the ‘scenario’ but no increase in the contribution of import prices (energy and other goods) to CPI inflation relative to its pre-Covid average.