QT and the MPC’s forecasts I want to turn now to the second question I posed at the beginning: should the MPC not recognise in its forecasts some particular and additional drag on demand and on inflation, on top of that induced by higher Bank Rate, from the ongoing “quantitative tightening” (or “QT”)? This began over a year ago, initially by failing to replace maturing gilts in the APF. In September, the MPC commenced outright sales of assets and said that, by both means, it would reduce the size its size by £ over the following year. Page 28  Readers who’ve come this far will be glad to hear that this section will be pretty brief because I’ve actually gone through the main points already. There are two. First, because the impact of QE has been variable I don’t think it would be right to pretend there’s some fixed, unchanging effect on the economy – to translate, for example, a given quantity of asset purchases (or sales) into some notional equivalent in terms of Bank Rate. It’s partly because of this, and the fact that we can only be less sure of its impact than that of conventional policy, that the MPC views Bank Rate is its “primary” policy instrument. By design, the Committee did not embark on QT until the official interest rate reached a certain threshold – a level from which (were the need to arise) it could then be cut.
Broad money grew more than twice as rapidly in the first fifteen years of inflation targeting (when there was no QE) than in the decade or so after the financial crisis (when there was lots). And average inflation, in both periods, was close to 2%. This definitely does not mean that these indicators are somehow intrinsically unhelpful or misleading. Apart from anything else – and this is a more general point, relevant for other variables too – the act of targeting inflation is likely to reduce its correlation with just about every leading indicator (those things, at least, to which policy has a chance to react, given the lags involved). There might be several indicators that would have told you something about future inflation had monetary policy failed to react to them. But because in practice policy does just that, using and then offsetting that information, what’s left will inevitably be less well correlated[17] with inflation. In the case of broad money, and at least with the benefit of hindsight, it’s not that difficult to explain  Page 29  “what’s left” in these historical data. For a long period of time, right the way through from the early 1980s to the financial crisis over a quarter of a century later, household wealth rose (relative to income) and, because banks increasingly paid interest on their deposits, it became increasingly attractive to hold financial assets in that form.