I’ve written about inflation before, and I’ll do so again, without doubt. As long term friends of mine (some who have suffered discussion of this issue for thirty years) know, inflation has always been relatively low on my list of economic concerns. I stress, not absent from my worries, but an issue that has to be placed in context, which very few neoliberals and even fewer politicians influenced by that way of thinking do. Given that the issue is now, undoubtedly on the agenda, that needs more explanation.
Inflation is, of course, a monetary phenomenon. Money (and I grossly simplify, but do so for important reason that no one else seems to be bothering to even think about the issue) has two functions. One is as a flow. This is the money that circulates in the economy to facilitate the ongoing cycle of transactions. The second use is money as a stock: the store of value and, to some degree, the measure of value. It is, almost instantly obvious that inflation is of potentially lower impact on the former than it is on the latter — subject to one massively important caveat and that is that those who are undertaking transactions can, within reason, keep their own cash supply growing so that whilst the absolute amount of cash they spend grows in real terms the value expended is, near enough, neutral. That means wages need to rise in line with inflation, especially for those on low pay — which means minimum wage adjustments are essential — and it means pensions and all benefits must be increased to ensure the least well off in our society do not suffer for inflation.
This identifies the first and most important risk from the current inflation. The government has changed the basis for indexing pensions and other benefits to make sure that although this government has deliberately increased inflation — by completely unnecessarily increasing VAT — they have ensured the poorest will suffer as a consequence. For these people inflation will matter, a great deal. So I am not indifferent to the issue — far from it. There is a matter of social justice to consider here.
There’s another issue of social justice too. Increasing interest rates now will, without doubt, remove cash from the UK economy. That will result in reduced demand for goods and services and that in turn will mean a loss of jobs in the UK. We’re already going to lose 1.3 million jobs over the next few years — people who do not deserve to lose their jobs. The VAT rise will increase those job losses. And so too will the impact of the inflation we’re going to suffer — inflation that, as I note below, is largely being imported into the UK, but to consciously increase these job losses by increasing interest rates to reduce demand will increase those job losses again. And that would be another issue of social justice — because those people do not deserve to lose their jobs for this reason.
And they do not need to do so, because the reality is that this inflation is being imported. Russian wheat shortages, imported gas and oil (and we are now a net importer), imported food and increases in the price of raw materials are what are causing this inflation, in addition to the impact of VAT rises. The VAT increase apart none of these will be resolved by any action the Bank of England or the government can take — unless they are willing to regulate speculation in raw material and food prices by hedge funds and others which are no doubt fuelling this crisis. So any action to reduce demand can only make this crisis worse for the working people of this country.
What then about savers? This is the constituency who will yell and shout about inflation. But I’d remind them — this is modest inflation. It is inflation of 3.7%. I accept that this means that many will be earning no real return on their savings. And of course that is going to be hard for some. But let’s also be clear: those with capital in the bank have been the winners from this economic crisis. Not one of them lost a penny despite the failure of the banks in which they held their money. In other words — to save the bank deposits of all who have savings in this country we accepted the most extraordinary cost of saving the banks. And the price for that has been enormous. You can add it up any way you like: but on the ground it is 2.5 million people unemployed, students paying fees they never expected, the destruction of our NHS, the loss of services to the most vulnerable in our society, poorer education, the loss of the education maintenance allowance, the increase in tax and falls in real earnings for those in work — which are inevitable. To date savers have lost nothing from this crisis: others have paid an enormous price to ensure that is the case. And remember, whilst many of this who read this might be savers most people aren’t. Significant savings are in fact the preserve of a tiny minority in society — and beating inflation is really about preserving their wealth, and not much else.
I’d in fact argue that most savers would be wise to stand back for the time being and accept a bit of inflation — even at cost to their capital. Most of those with modest saving are pensioners — and of course I am concerned for them. That is why I argue that they should have properly index linked increases in their state pensions and other benefits. But pensioners would be wise to remember too that they are dependent on others to look after them in just about every way. People in work make all they consume. People in work supply the health care, social services and other facilities that many pensioners are reliant upon. Those services need to be maintained. They won’t be if there is a recession. And those services need people who can work for them on wages that let them meet their own responsibilities — whether to pay their mortgage or feed their children. And those are pensioners grandchildren, lest they forget.
Yes there is a problem with inflation reducing the stock of value in saver’s accounts.
But let us also note inflation — and what we face is very modest inflation — has a benefit too. It reduces the value of people’s debt. The saver’s loss is the borrowers gain. And the reason why we have an economic crisis is because banks over lent, on property, for consumption, for speculation. The banks made this money- banks make almost the money that exists in the UK. And it was money that fuelled the savings of a few and the debts of many — the many who will be crippled if mortgage rates rise. That many are being crippled by debt — and the young face this more than almost anyone. And in my experience as someone in middle age, with many friends with children in their twenties, this is a cause of massive concern to many who will be pensioners soon. They no longer work to save. They’re working to pay off their children’s debt. It’s an extraordinary situation, and inflation will help these young people. If property prices fall but debt is written off by inflation then there’s a chance young people might be able to do something many of their parents took for granted — they might be able to buy a house with the prospect of paying for it before they retire. And that too is pretty vital for most pensioners — because for many of them more of their savings are locked up in housing than anything else — and without buyers for those houses their prospect of realising the value of those properties is low. Inflation might, curiously, help them do that — and at the same time let them know their children might do as well as they have — which is a situation so many parents aspire too.
So who are those who might really lose? Banks will. They borrow short and lend long. That results in real losses to them. And the rich — those with considerable wealth may also lose — but candidly only if they hold their assets in cash, and most in this group do not.
And business? Will it lose? No. Not at all. Business needs inflation. It needs it to be able to give pay rises, which keep people happy, without having to bear the full cost themselves. They need inflation to encourage them to invest now because it will cost more later. And managers need inflation because it is always, always easier to manage a business when numbers are increasing — even when some is from inflation. Of course that breaks down when inflation gets out of control — which may be the case when it hits double digits, but we’re far, far away from that with no prospect of it happening because there is no prospect of wage inflation in this country at this time with unemployment at its current rate.
So overall, what’s the problem with inflation? Right now there is just one of consequence — which is that the poorest in the UK might suffer most from it and need protection. Thereafter do we have a problem that should be addressed? My answer is no, we don’t. But more than that, addressing this issue will make the problem much, much worse, all to protect those who have enormously benefitted from the spending to save our banks. They’ve already had their social justice. Now it is time for others to get it. And let’s face it, inflation at 3.7% is neither here or there for most people. Once we protect the poorest in our community our priority is to keep everyone else who can be in work. And any action we now take to address inflation will put many more people out of work — and that would be a disaster — including for most of those with savings.
And remember — unless the ConDems raise VAT again next year quite a bit of this inflation falls out of account.
So let’s keep calm and carry on.
NB I discussed thse issues on Radio 2’s Jeremy Vine show today
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Inflation is a tax ,permitted by the Bank of England,whose Governor has now failed to meet his remit every other month for nine years.In so doing,by keeping interest rates beneath inflation,he has legalised a swap of wealth away from the saver to the borrower.The fantasy of ‘no more boom and bust ‘is now exposed.Base rate will return to 5 percent by December,2012,with the normal consequences.
@william
Very politely, what utter tosh
The saver need not save in cash
The borrower did not seek inflation
Inflation is not a tax – the government does not raise a revenue As a result (albeit debt is repaid)
And this inflation is, in any case, imported
As for 5% rates – no way – when VAT is washed out of the system the real inflation rate is just 2%. You say we’re going to move to 3% real interest rates? Only a government committed to massive electoral suicide would allow that – and if the BoE tried I am sure bank independence would be out of the window faster than you can imagine
So as I said – utter tosh
Inflation is not a problem at 3.7% It is a problem when it gets to 7-8% or higher. And the higher it becomes the more unpredictable it tends to be: there is no such thing as high and stable inflation.
Having said that, inflation (or lack of) is more a sign of the health of an economy than unemployment (or lack of) is. As far as I am aware there is not a single example in history of what you could call a “successful” economy experiencing high inflation for any length of time. By contrast, there have been many examples of countries with economic growth above the norm for sustained periods whilst simultaneously experiencing stubborn unemployment (e.g. Germany since the 1990s, UK in the 1980s, much of Central and Southern America in the 1980s).
High inflation is almost always a sign an economy is going down the pan. High unemployment, not necessarily so.
Richard,
Thanks for a very informative piece.
There is one point I’d just like to raise. You are obviously correct when you say the key factors in the rate of inflation are imported – the cost of fuel, other basic commodoties such as steel and copper, and food, which we largely import. And it follows that you are right that the UK interest rate will have little bearing on those costs.
But, if we accept that the costs of those products are rising because of basic supply and demand (with developing countries demanding far more of these products as they grow), is not the unavoidable truth that at some point the west is going to have to accept that these products simply cost more and that we need (overall) to accept a decline in our living standards. Of course we can argue about whether speculators are fuelling the price increase, and we can argue about how the burden of increased prices should be split between rich and poor, but is the basic truth not simply that energy, food and most produced goods are going to cost more and more as time goes on, and we as a people are going to have to get used to having less than we used to have? Is that the truth that dare not speak its name: that we are at the start of the decline of the West?
High inflation is almost always a sign an economy is going down the pan. High unemployment, not necessarily so.
The latter, without extremely generous welfare transfer payments, is the sign of a society going down the pan.
Is that the truth that dare not speak its name: that we are at the start of the decline of the West?
Hardly, we have most of our structural and social (for now) capital in place. A rise of the non west should not necessarily impose a decline of the west.
Whether price rises will benefit the majority in the non west is a question though.
@mad foetus
Yes
@paul
True
@Nick Kitchin
Utter tosh
Read 23 Things They Don’t Tell You About Capitalism by Ha Joon Chang
When we didn’t worry about inflation we had no banking crises, high employment, high growth, stable society
When we worried about inflation we got banking failure, stress, high unemployment, social disorder, big inequality and low growth
Coincidence? I don’t think so
Get your facts right
10% is not high inflation either
@Richard Murphy
Sorry Richard, but if Greenspan (and al.) had REALLY worried about inflation, he would have done something about the successive asset bubbles that inflated under his watch. With a less accomodating policy, there would have been no dot-com, no sub-prime and no global financial meltdown.
Also if global authorities were REALLY concerned about inflation now, then Bernanke, with a little help from China, would do something to kill in the budd the emerging commodities bubble. He would most definitely NOT be printing another $600 billion of QE to add to the circa $3 trillion that he has already booked on the Fed’s balance sheet.
Much of our current problems originate from a time in the early 1990s when policy makers, market operators and some sections of academia believed that we had conquered the business cycle including inflation. The complacency that followed is the cause of all that went wrong.
@Million Dollar Babe
So your problem is with neoliberalism and all it promotes
I agree – that’s the problem
But you have no solution
Thankfully some of us have
@Tax Research LLP
Respectfully, this is not the case. The issue is not with our economic structure.
The problem is with irresponsibe central bankers (who in fairness suffer from the the fact that the Fed’s mandate is very poorly defined), equally irresponsible polititicians (of both sides, in Congress and in the White House), and ineffective regulators (with the British FSA the most ineffectivbe of the bunch).
Happy to debate your “solutions” in another thread.
@Million Dollar Babe
Oh come on. Don’t push the boundaries of credibility
They all had an idea in common – and it was neoliberalism
To say otherwise moves you even further into the realms of the complete fantasist