​A herd of elephants in the room.

In a speech at the end of September, on his last day as chief economist at the Bank of England, Andy Haldane recalled his first truly momentous day, 16^th September 1992. Otherwise known as ‘Black Wednesday’, that was the day when the UK was forcibly ejected from the European Exchange Rate Mechanism (ERM). Haldane witnessed from the foreign exchange desk the loss of £20 billion (real money) in reserves blown in defending the Pound on that day.

His speech goes on to cover the bank’s role in setting monetary policy. After leaving the ERM, another ‘anchor’ for policy was needed, and inflation targeting was selected. This was novel but, as Haldane says, following its independence in 1997 the bank’s brain and hands became fully and durably connected by statute.

Since 1992, inflation has averaged 2%, precisely in line with the target anchor.It is not entirely clear whether this is down to skill or luck. Certainly, the so-called NICE era is over: non-inflationary cautious expansion. We are now in a VILE era: volatile inflation limited expansion.

Yet the anchor remains set at 2%, whilst the regime is being tested as never before. The Covid crisis has seen interest rates cut to their effective lower limit, and QE has been undertaken on a massive scale. By the end of 2021, the Bank will hold £1 trillion of nominal Government assets, or around half their total, and representing 40% of GDP.

Haldane observes this to be an uncomfortable spot. Firstly, whether continuing monetary stimulus is consistent with the inflation target. Secondly, whether monetary policy strategies are at risk of time-inconsistency, fiscal dominance, and the erosion of central bank independence.

There has been a clear and marked bounce back in economic activity now that working, shopping, and socialising have resumed. However, Haldane identifies two large and powerful sources of economic energy.

In the public sector, QE is still providing stimulus, as is fiscal policy, to the tune of 15%-20% of GDP.

In the private sector, the lake of involuntary savings resulting from effective restrictions in spending during lockdown stands at around £200 billion for households and £100 billion for businesses. Leakages from this are fuelling spending on goods and assets, and clearly could finance demand at scale for some time.

With labour shortages and rising inflation indicating an economy running hot, these sources of economic energy could cause overheating.

Haldane concludes that inflation expectations and monetary policy credibility feel more fragile than at any time since 1992, and that immediate thought and action are needed to begin unwinding QE.

Interest rates could therefore rise much more quickly than the markets expect if the bank is truly independent.