Inflation trap

There has been a common wisdom - which was put to practice - that when inflation was going up above the set target, Bank of England (or a relevant central bank in other countries) responded by increasing interest rate. The reasoning behind was that there was too much money in circulation (called broad money supply). This was according to the following mechanism: people were borrowing a lot, they typically spent this money, this money returned again to banks and was re-lent again. The increased interest rate made money more expensive to borrow, hence people could borrow less and usually existing borrowers had to pay more interest on the existing loans. This was suppressing inflation as people had simply less money to spend but the actual mechanism worked through suppressing the volume of money on the market: broad money supply.

The current wave of inflation in Britain is a result of the pyramid scheme engineered by the financial industry. Once the financiers - using a crude pyramid scheme mechanism which was lending with loan to deposit ratio greater than 100% - raided the banks cash reserves the government stepped in and pumped hundreds of billions of pounds into the banking system by directly rescuing the banks and by quantitative easing. The former put the government into heavy debt. In the latter case money is finding its way to the consumer markets causing inflation. All these resulted in pound stirling losing credibility. The situation of other major currencies, US dollar, euro, yen are the same or worse. Hence investors, globally, started moving to a safe heaven of commodities. They started to convert their currency based investments into investment linked to commodities. This causes inflation which in turn undermine currencies even more and the process continues.

The current figures show that the growth of broad money supply in the UK is very low and is lower than the growth of narrow money supply (see graphs below). This means that money multiplier is going down (as money multiplier can be expressed as a ratio of broad money to narrow money). The financial market keeps balancing itself but in the meantime the currencies have little credibility and investors want to minimise a risk of holding them by moving to commodities. Therefore Bank of England faces unprecedented situation: the inflation is going up but raising interest rate would not stop it as the inflation is not a result of high growth of broad money supply. In fact raising interest rate can further damage economy and make things worse by slowing the growth thereby ability to repay the public debt.

Raising interest rate is not a solution and Bank of Englad knows it. Its Governor acts wisely but does not say everything. The problem is, however, that the money multiplier is so high that inflation caused by it is likely to be going up for quite a while. We are getting poorer thanks to the pyramid scheme engineered by the financial industry. The Bank of England Governor Mervyn King observed that "inflation could cause serious problems for families over the next three years". You can say it again, Mr King. And in the meantime the captains of the financial industry keep rewarding themselves handsomely with the money raided from the middle classes since this is what high taxes, spending cuts and inflation are all about. "Prime Minister, sort out this mess, please"

Source: Bank of England