Pointless monetary and fiscal tightening will land us in a major recession and trigger a depressive doom-loop
The economic reasoning behind current monetary policy is poorly thought out, joining a similar hiatus in fiscal policy. Once inflation had been precipitated by major monetary expansion, as occurred during Covid with massive money printing, it was always going to take time to get it down again. But come down it will, as now we have had a sharp tightening of monetary policy.
A further element bringing it down is the reversal of commodity prices after their big spikes a year ago. Producer wholesale prices were in June up by only 0.1 per cent on a year ago, while input prices were down by 2.7 per cent. The process of falling inflation is in train, but patience is needed with the unpredictability of the lags involved.
Instead, the Bank of England is continuing to raise interest rates in what seems like a blind panic at inflation being above its long run target of 2 per cent. To worsen matters, the Treasury is also reacting irrationally by encouraging more fiscal tightening, on top of the tax rises already in hand that have contributed to low growth expectations. Yet the Bank is already over-tightening.
These policymakers have focused on wages as a source of ongoing inflation. But wages have simply been catching up with unexpected inflation, so restoring real wage equilibrium. That process has a bit further to go, and wages will keep rising until catch-up is complete. This will also happen in the public sector and must be permitted, in order to preserve public services. But this catch-up is not causing fresh inflation. As inflation comes down, wages will grow at the newly expected inflation rate, slowing in line with falling inflation.