Massive taxpayer handouts and a money-printing spree helped stoke inflation in Britain and around the world, with years of interest rate pain now needed to get the crisis under control according to a top central banker.
Agustin Carstens, head of the Bank for International Settlements (BIS), said that governments and central banks went too far in dishing out cash during Covid.
The authorities now face a battle to bring inflation under control that could last until 2027 according to the institution, which is known as the central bank of central banks.
In comments that will be regarded as critical of the policies pursued by the Treasury and Bank of England after the pandemic struck, Mr Carstens said: “While understandable as the Covid crisis broke out, with the benefit of hindsight, it is now clear that the fiscal and monetary policy support was too large, too broad-based and too long-lasting.”
In Britain, the Bank of England cut interest rates to 0.1pc when lockdown was imposed and launched two vast waves of quantitative easing, printing money and pumping it into the economy by buying bonds.
This support only came to an end in December 2021, when policymakers were forced to raise rates to tackle rising inflation that they had initially dismissed as transitory.
Mr Carsten’s comments contradict claims by the Bank, made at a select committee hearing in May, that the idea quantitative easing caused double-digit inflation “is not well supported”.
So far the base rate has risen to 5p but inflation is still at 8.7pc, more than four times the Bank’s 2pc target.
Meanwhile. the Government borrowed sums never before seen outside of wartime, and gave handouts including higher benefits and the furlough scheme to employees who were paid to stay at home for much of the pandemic.
Borrowing has stayed high ever since, with a budget deficit of around £130bn expected this financial year, while the national debt is bigger than annual GDP for the first time since 1961.
Mr Carsten suggested that in the wake of the financial crisis, central bankers had been too quick to give the impression rock-bottom rates would last forever.
He said: “Low rates as far as the eye could see encouraged further debt expansion, public and private,.
“Moving forward, policy needs to be more realistic in its ambitions and more symmetrical over the business cycle. Buffers used in downturns must be rebuilt in recoveries. Unrealistic expectations that have emerged since the great financial crisis and Covid-19 pandemic about the degree and persistence of monetary and fiscal support need to be corrected.”
The financial chief said it was critical to crack down on inflation now before it becomes embedded in economies.
Warning that “a wage-price spiral could set in” as workers push for pay rises in the face of rising prices, he said: “Once an inflationary psychology sets in, it is hard to dislodge.”
The recent falls in inflation around the world have largely come from drops in energy prices and the end of Covid’s supply chain chaos, but underlying inflation, particularly in the services sector, has not gone away.
This could mean officials mistake the fall in energy prices for proof that they have conquered inflation, and so fail to raise interest rates far enough.
Mr Carstens said: “Central banks may think that they have done enough, only to find that they need to tighten further.”
If inflation refuses to fall, interest rates may need to stay high until as long as 2027, according to one economic scenario studied by BIS.
This comes with the added risk of financial crises in a world economy which has become used to low interest rates.
BIS said that the pensions crunch in the UK last autumn, the failure of Credit Suisse and the US banking collapses earlier this year are all early signs of the strains spreading through the financial system as markets adjust to higher rates.
The Treasury insisted it was committed to getting the deficit and rising prices under control.
A spokesman said: “We will not hesitate in our resolve to support the Bank of England as it seeks to squeeze inflation out of our economy.
“We rightly spent billions to protect families and businesses from the worst impacts of the pandemic.
“But we won’t leave future generations with a tab they cannot repay so we have taken difficult decisions to balance the books and get debt falling.”
