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‘Central banks mistakes led to inflation’ says former Governor of Central Bank 

A former governor of the Bank of England has said that the mistakes made by the Central Banks in the west during the Covid lockdown predictably led to inflation, after governments lost control of the public finances. 

Lord Mervyn King, the former governor of the Bank of England said that even as the economies of the west were contracting because of lockdown, “central banks decided it was a good time to print a lot of money”.

He said that this was a mistake which led to inflation – as there was “too much money chasing too few goods”. The financial expert said that the sharp rises in inflation was “predictable” and that the financial markets were now responding to governments losing control of public finances as countries were over-borrowed. 

 

“Markets are not in charge. Governments and central banks are. Markets respond to the announcements made by government and central banks. And central banks have lost control of inflation – government lost control of the public finance; not surprising that markets respond to that,” he told  BBC’s Laura Kuenssberg

“I think all central banks in the west, interestingly, made the same mistake. And during Covid, when the economy was actually contracting because of lockdown, Central banks decided it was a good time to print a lot of money,” he said. “That was a mistake. That led to inflation.”

“We had too much money chasing too few goods. And the result was inflation. That was predictable. It was predicted, and it happened. So that’s one problem we have to try to get out of. But the public finances both in the United States and the United Kingdom were not put on a sustainable track. And markets responded to that.”

King has emerged as a critic of what he sees as an unsustainable trend in government and central bank policy to rely on money printing or quantitative easing as a solution to all ills. 

Printing money to meet the cost of Covid lockdowns (think the huge PUP bill in Ireland, for example) is actually a way for a government to take out more loans. When the government needs more money to meet the cost of spending, those bonds are bought by the central bank.

While interest rates are low, this can provide cheap loans, but as inflation starts to rise – and spending gets out of control – the interest rate now required to keep the investors in the bond markets happy starts to climb, and bond prices start to fall, signalling a loss of confidence in governments that are over-borrowed and committed to enormous spending.

(One Bloomberg commentator notes that while the “common wisdom” has it that the financial markets “punished” Liz Truss’s government what might have been seen as reckless plans for enormous spending and tax cuts. But he pointed to where the slump in UK government bonds occured – in 30-year gilts – and says UK pension funds “had bought long-term gilts with borrowed money and entered derivative contracts to the same effect — positions that generated huge collateral demands when prices fell and yields rose. To raise the necessary cash, they had to sell more gilts, creating a doom loop in which declining prices and forced selling compounded one another.” It’s an insight into the complexity of the markets and the danger of playing with derivatives, but the principle does remain the same – no-one, not even the government of England can keep borrowing indefinitely without spooking the markets.)  

While some political and economic commentators have sought to blame the war in the Ukraine for soaring inflation, the truth is that a cost of living crisis was already well underway before the Russian invasion and it was driven mostly by the policies around the Covid lockdown and printing money.

Now that soaring energy costs have exacerbated the trend, it remains to be seen whether inflation can be brought under control, even as the Bank of England and the European Central Bank continue to hike up inflation.

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