Monetarists warn of ‘severe recession’ and risk of deflation as money supply falls
Monetarists are warning that the UK is facing a “severe recession” as the money supply falls sharply in the face of the Bank of England’s interest rate hikes.
According to Bank of England data, the flow of broad money contracted 4.2 per cent annually in September, having turned negative in August for the first time since current records began.
Although about a third of this contraction stems from the quantitative tightening programme, September’s contraction means the money supply contracted at the fastest rate since the early 1920s.
“This is an alarming monetary squeeze of a magnitude unprecedented in the post-war period, and greater than anything seen during the global financial crisis, when central banks were concerned with the prospect of a deflationary spiral and forced to introduce QE,” Damian Pudner, director of the Institute of International Monetary Research told City PM
A school of economists, known as monetarists, argue that changes to the money supply are by far the single most important factor driving inflation.
Broad money comprises notes and coins, bank deposits, and other financial instruments similar to cash.
“You do not have to be a die-hard ‘monetarist’ to worry that money and credit growth are collapsing,” Julian Jessop, economics fellow at the Institute of Economic Affairs told City A.M.
“At best, this means that inflation is set to fall much more sharply. At worst, it is signalling a severe recession,” he continued.
Pudner similarly warned of a incoming recession.
“A UK recession in 2024 is all but inevitable. The money supply has consistently proven itself to be a crucial indicator for forecasting economic growth and inflationary trends, and one that our policymakers can ill afford to neglect.”
Many monetarists argued that the surge in inflation in 2021 was driven by the rapid growth in the broad money supply, which hit 15.4 per cent in the year to February 2021.
Even though inflation remains at elevated levels, monetarists warn that a collapse in the money supply could even lead to deflation in the coming years.
A number of leading monetarists recently wrote an editorial in the Financial Times warning that “if the quantity of money continues to slide, there is a possibility in 2025 or 2026 of beneath-target inflation or even deflation.”
However, many economists are sceptical of the direct relationship between the money supply and measures such as GDP and headline inflation. A number of different factors influence how developments in the money supply influence the economy.