The Bank of England calls up the inflationary monster

The Committee unanimously agreed that the Governor should write on its behalf to the Chancellor to seek authority to conduct purchases of government and other securities, financed by the creation of central bank money using the APF.

Minutes of the Bank of England Monetary policy Committee, February 2009

There it is; the fateful sentence where the MPC begins to debauch the currency and tries inflate its way out of trouble The MPC have just called up the Kraken from the deep. Of course, they arrogantly think they can control this inflationary monster. They will quickly discover that the monster will control them.

As we look out at the rest of the year, it is hard to imagine a huge surge of inflation suddenly coming upon us. The economy is slowing quickly; unemployment is rising and firms are going bankrupt across the country. This doesn't seem like fertile ground for an surge of inflation.

Look beyond a six to 12 month horizon, and things look very different. An election will be on the horizon, the government will be running the largest deficit since the war and the Bank of England will be providing the cash to finance this fiscal gap.

By then, the Bank of England will also be politically trapped. It will be caged by circular economic logic, which starts with the idea used to justify quantitative easing; that the BoE needs to print money to prevent a recession.

The increase in the money supply, however, will end up financing the government's deficit through the purchase of government bonds. This will keep public expenditure at elevated levels, and of course, the government will pressurize the BoE to keep the easy money flowing. Without it, the government will have to cut back on all that public sector gravy it loves to spread around. Any attempt to curtail monetary growth, in turn, will cause a recession, which is why the BoE started printing money in the first place.

In a mechanical sense, all inflationary surges occur when central banks print huge amounts of money, but fiscal pressures provide the incentives to keep inflation going.

At the moment, everyone has compartmentalized UK economic policy. So far, no one has paid much attention to the interaction of monetary and fiscal policy. The Bank of England has just re-established a link that will lead to the monetization of the fiscal deficit. That is all you need for double digit inflation and economic chaos.