Real Interest Rates

Otmar Issing

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Inflation in UK
Two pieces of data are now screaming danger.
Martin Wolf June 15 2007

First, two years ago the spread between 10-year conventional and index-linked bonds was 2.7 percentage points (270 basis points). Since then this has risen steadily, to reach 370 basis points, implying an increase of 1 percentage point in the implied expected annual rate of inflation.

The second piece of information is the soaring growth of broad money. As Mr King noted only this week: “The quantities of broad money and bank lending are now around 14 per cent higher than a year ago – rates of growth last seen in 1990 when inflation was more than 8 per cent.”**

Interpreting changes in the growth of the stock of broad money is difficult and, in the UK, extremely controversial. Many economists suffer from a visceral unwillingness to accept that the broad money stock has any significance for inflation. Even people who consider themselves monetarists focus on narrow measures of money even though these seem unlikely to have any economic impact.

This aversion is a puzzle. Both fundamental theory and experience suggests that broad money matters.

These developments also raise some questions about the process of selecting members of the MPC. It might be helpful if its members were a bit more heterodox: someone with the monetarist views of, say, Otmar Issing, the former chief economist of the European Central Bank, would be helpful.

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