Ben Broadbent: Monetary policy - prices versus quantities

Speech by Mr Ben Broadbent, Deputy Governor for Monetary Policy of the Bank of England, at the National Institute of Economic and Social Research, London, 25 April 2023. 

The views expressed in this speech are those of the speaker and not the view of the BIS.

Introduction and summary

Good morning!

An old question in economics is this: is it right to think of the stance and effects of monetary policy in terms of interest rates and asset prices – or are these things better measured by the size and growth of banks' balance sheets, whether that of the central bank ("narrow money") or commercial banks ("broad money")?

Old it may be, but this question throws up a couple of others that are relevant today.

First, is the inflation we're experiencing mainly the result of the growth in broad money in 2020 – and were both the "inevitable" result of the QE conducted that year, as some have said?

Second, how does the MPC take account of asset sales ("QT") in its economic forecasts – does that not require an additional and explicit estimate of its impact on activity and inflation?

Given the extraordinarily high inflation we've been experiencing in the past couple of years, and the use of "unconventional" policy over the past decade or so, these are important and legitimate questions. That is my excuse, at least, for the inordinate length of this speech (for which I apologise). I have attempted to summarise the main points in this introduction.

In some ways the opening question – should we think of monetary effects in terms of prices (interest rates and asset prices) or quantities (monetary aggregates) – draws the contrast between the two a little too starkly. They're not mutually exclusive. In the so-called "IS-LM" model, through which many people are introduced to macro-economics, a rise in the supply of money does eventually lead to a proportionate rise in consumer prices. It's just that it operates via interest rates. That's because, as long as people are free to borrow and lend, demand in these models is fully pinned down by current and (expected) future real interest rates. The expansionary effect of an injection of money therefore relies on its first depressing the yield curve and the stance of policy is fully captured by the prevailing level of interest rates (relative to some underlying, "neutral" level).