Britain does not need a rate rise to beat inflation: it needs labour market reforms to improve pay

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I have a complicated relationship with inflation. I strongly suspect that should be true of most people who think about the subject. I regret that this rarely seems to be the case. News that the UK's headline inflation rate has exceeded 2% for the first time in a number of years, whilst pay increases happen to have simultaneously fallen to the same current 2.3% rate, provides an opportune moment to think about this.

When discussing inflation there are several key issues to consider. The first is the context of the discussion. In other words, just what aspect of the issue is being discussed? The relationship between inflation and wealth might be very different to the relationship between inflation and income.

Then there is cause of the inflation. Inflation comes in a number of varieties and they need to be viewed differently.

Thirdly (for the sake of brevity) there are the consequences of the inflation and whether they create a desire to counter its impact. Ignoring any of these three issues, as too often happens, is dangerous: wrong answers are easy in this area.

Looking at context first, with regard to wealth the impact of inflation is unusually predictable. Inflation erodes the sum a debtor owes to the person who has lent to them. Deflation increases the sum owed to a lender. In quite straightforward terms inflation reduces the financial wealth of those who own debt and increases the net financial worth of those who owe money. Since the owners of debt are, by definition, wealthy it is very easy to see why inflation has come to be seen as the curse that it is usually represented to be. Low inflation preserves financial wealth so low inflation is good is the logic, and it has prevailed, and this despite the fact that few in the baby boomer generation (including me) really paid ever paid for our mortgages as a result of inflation. They were llargely written off for us over time.

Whilst mentioning context it is also appropriate to note what is measured: asset price changes are not reflected in inflation. As a result a measure that is used to preserve financial wealth for the benefit of a few does not take into account massive increases in asset price when it is calculated: a measure more conveniently contrived to achieve the goal of preserving wealth divides in society whilst ignoring the unearned increase in them resulting from unwarranted asset price increases could not have ever been invented.

There are two conclusions a this stage then. The first is that inflation that erodes financial wealth is to be welcomed for its benefit to those who owe money. The second is that inflation is woefully inadequately measured because it ignores asset price changes and so, by implication, one of the biggest costs of living  in the form of house prices.

Next let's consider the cause of inflation. This is not the point to write a book on this issue, which would easily be possible. Instead it is worth noting two general types of causation. They are the controllable and the uncontrollable.

Let me deal with the second first: uncontrollable inflation arises from economic actions over which the government whose currency is inflating has little or no control. That is things like oil prices. It might also be major currency realignments, such as the collapse in sterling post Brexit. These are fundamentals beyond the influence of the tinkering within the system that a government can undertake. There is only one thing to do with them, which is live with them and let them work through the system, as in time they will, even if secondary consequences usually take time to stop bouncing around. The required response to this pressure is by and large resignation to its impact, like it or not. Or it is to question why it has arisen and what in the long term can be done about it e.g. to change oil dependency via investment in green energy. But fighting the beast at the time it arises is largely foredoomed to failure.

This contrasts with controllable inflation arising from situations capable of being influenced by the government of the state whose currency is inflating. These might be wage inflation; excess demand in the economy or a shortage of taxation to counter the level of government spending in a situation where  full employment, or something close to it, exists. All three can , in different ways, create inflation and each can be addressed.

The first drove Thatcher to crush union rights: they are now such a distant memory for many that they would just love an employment contract; dreaming of someone to collectively negotiate the pay rate is in the realm of fantasy.

Excess demand is an absolute and a relative term: absolutely it indicates an unjustified exuberance beyond the capacity of the economy to meet demand. Relatively it is an exuberance of demand relative to the capacity of people in the economy to pay. The responses are quite different. The first needs interest rate rises; the second pay rises.

As for inflation due to insufficient taxation, we have seen the exact opposite for a long time: the inflation rate has suggested over taxation. The required response is in fiscal policy.

The point of the discussion is, I hope, very clear: interest rate adjustments are not an appropriate response to much inflation.

So what are the consequences of inflation?nI hope it is apparent by this point that they should be nuanced by the context and cause of the inflation. In some cases no response ia appropriate. In others fiscal or monetary policy can play a role. But it is also possible that inflation (and its absence) indicates a deeper malaise, such as dysfunctional labour markets where asymmetry of power is prevalent; over dependence on imported energy; inappropriate balances of power in international trade, and so on. Neither fiscal or monetary policy address these: deeper action is needed.

It is my suggestion that this is where the UK finds itself now. It is true that there is too much debt, but to control that with interest rate increases will exacerbate the true crisis, which is a shortage of labour income within the economy as a whole.

It is also true that most of the current inflation is uncontrollable, unless Brexit us cancelled and OPEC respond by increasing oil supply, both of which are incredibly unlikely.

In that case, let's be clear; the UK does not need an interest rate rise now. But labour markets are in need of fundamental reform to support and improve long term lay rates, and there is no sign of that happening. That's the big issue around inflation that needs addressing. And there is no one to address it. And that may be the biggest failure in UK political economy right now.