Mark Carney appears to want an interest rate rise. I think this is economic madness. I have a different policy proposal to make in its place. I believe that now is the time for the Bank of England to set out a case for an increase in the inflation target.
As the Bank of England says of the inflation target:
The inflation target of 2% is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI). The remit is not to achieve the lowest possible inflation rate. Inflation below the target of 2% is judged to be just as bad as inflation above the target. The inflation target is therefore symmetrical.
But why it is 2%? It is harder to find justification for that. It 'just is'. And why is that so? Because, I suggest that sometime, somewhere, someone thought 'that's about enough'. And what does enough mean? It's the figure that does not debase wealth too much (which is terribly important around Threadneedle Street and some parts of SW1) whilst keeping the economy about of deflation, which most informed people think delivers recession pretty quickly.
The second half of their argument I have a lot of time for: deflation is a danger to be avoided at just about all costs, in my opinion. That a fall in the value of the currency might destroy real opportunity in the economy is unforgivable in my opinion, and it's right that the Bank should steer clear of it.
But what of the first half of the argument? I'm entirely opposed to the suggestion that significant inflation is good for an economy, although I do not recall things as being as bad as popular legend says it was in the 70s when inflation at rates we can now hardly comprehend did not create anything like the disruption claimed of it. But equally, I see no reason at all why we should keep inflation to 2% so that the owners of debt (and debt ownership is the basis of wealth) should have their asset values preserved, which is the only reason why I can see the current target is so low.
Would the world end if the target was 3%? Or 4%? Or even 5%? I'm not suggesting any more than that, and might only go for doubling to 4% to be honest. The obvious answer is it would not.
It's true that those owing money would have that written off faster by inflation. But that would diffuse the debt crisis. And it would reduce inequality. Both of those should be key economic targets for any government.
And that rate of inflation would allow for wage growth in proportion to asset prices - and most specifically house prices - which is vital.
Such a rate may also allow real wage rises - which has to be good.
Critically, this inflation target would also mean that interest rates need not rise - rate rises that will tip millions into unmanageable debt scenarios and which might precipitate a new banking crisis as a result.
I'm going to be blunt. The only reason I can see for an interest rate rise at present is to preserve the interests of those with wealth. And their interests have already been extraordinarily well served by our economy.
Increasing the inflation target would be in the interests of everyone else in the UK at present.
There is a real choice to be made on this, and right now the Bank of England is most definitely backing the wrong policy.
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There are good reasons for 2%, think through it. We don’t want deflation (or 0%), so we need some sort of positive target.
Having decided we want a positive number, the discussion is then about how high should it be. There is of course no limit forcing a decision. You could have a 4% target or 5% or 3% or 2.5% etc. The limit on how high an inflation rate we can have without the rate working against the economy is an external one. the Pound floats on a world market and our exchange rate depends on the relative demand for our currency against a trading partner. For 2 trading economies, the country with the higher inflation target will have the weaker currency. (look at the GBP-rupee rates). This is called the Fisher equation which has decades (if not centuries) of evidential support. And if you think about it, if you’re an investor you are going to prefer a country where your money doesn’t lose as much value (to inflation) each year so you move money from high inflation countries to low inflation countries. This capital flight is the reason developing countries with higher inflation have restrictions on moving money out of the country (see: China, India)
What this means is that there would be no problem with a higher inflation target…as long other large trading economies agreed to move their targets up as well. Doing it unilaterally is almost certain to result in a weaker pound (so generally higher prices anyway).
And it should be remembered that 2% is more a benchmark than a target as interest rate changes don’t follow some automatic “if-then” logic. 2% is a level above which the BoE begins to worry about an over heating economy. They may or may not react to it. inflation touched 4% in 2009 I think and the BoE lowered rates
You sought to justify the status quo for one interest group
You did not consider the benefit of a difference, which the exchange rate movement simply irons out
What about pension savings?
If you think pensions are paid out of savings you really do not understand pensions
http://www.financeforthefuture.com/MakingPensionsWork.pdf
I agree wholeheartedly with you on this one.
The basic case makes sense. Not to Mr Carney perhaps, because he’s almost certainly playing a tune from a different hymn sheet. Let’s face it, he’s still thinking asset price protection. We are not his paymasters we don’t call the tune.
Clarify please, if you would “deflation is a danger to be avoided at just about all costs, in my opinion. That a fall in the value of the currency…..”
A fall in the value of the currency relative to what?
Surely INflation reduces the the value of the currency? Are you talking exchange rates here?
As noted already, I view money from an economist’s viewpoint – i.e. It’s price in relation to what it buys. Deflation reduces that – real prices denominated in money falls
Looking after the interests of retired rentiers is big business because of aging population and the growth of self-funded retirement. Boring business but big and politically big as well. And tricky. Basically retirees need alternatives to those currently on offer and if the state can provide the alternatives it may be a good idea because it would get governments out of a tricky political bind where real interest rates are concerned.
You’re right, we can’t overall conduct policy to suit old rentiers so things like the sort of bonds you mentioned in your PQE proposal may be the best kind of alternative.
By the way FYI Krugman and Baker and other prominent minds have interesting things to say about the ideal inflation target:
https://populardemocracy.org/news-and-publications/prominent-economists-question-fed-inflation-target
https://webspace.princeton.edu/users/pkrugman/pksintra.pdf
https://www.bloomberg.com/view/articles/2017-06-09/the-fed-needs-a-better-inflation-target
And remember: the target rate in Australia is 2-3%. Its uncontroversial and the only folk in Australia who do argue are those that want to raise it.
Many thanks
Deflation is not a decrease in the value of the currency. In fact quite the reverse. Inflation is a decrease in the value of the currency.
If you’re plating pedant (and like many, that’s all you can do) that argument can be made.
But it’s entirely appropriate to say in response that all things are relative and and money has no value barring its relationship with other goods. It is wholly apparent that the decrease I referred to was the declining value of money required to purchase a fixed amount of other goods.
But you’d rather ignore the issue and play semantics instead. Now why might that be?
Oh dear.
That’s the 2nd time someone has picked up on that one. When I saw it I assumed that R. Murphy made a misplacement error in the haste of writing, putting the word ‘currency’ where ‘price’ should have been, or something like that, depending on what he meant in context. I then thought nothing of it because every thing else that he has written on this subject (and in this post) accords with a sound understanding of the basic points and not everyone has the time or resources to afford proof readers to perfect their syntax.
For the record, the basic points are that: inflation decreases the value of the currency, deflation increases the value of the currency. Deflation decreases prices (the amount of money required to buy things). It decreases the prices that producers receive, thus directly reducing their incomes. It increases the real value of debts thus decreasing the net income of debtors. The effect that deflation has on producer’s prices and business debtors undermines employment. Unemployment suppresses wages (the price of labour). Deflation thus reduces wage income indirectly as well as the net income of indebted employees and aggregate demand overall.
No wonder then that the well-informed people don’t like it.
So, when we consider ALL of that you’ll probably find that it is largely consistent with what everyone has said about it on this post and forum.
Cheers.
I thought I’d explained the perspective from which I wrote?
And suggested this is dependent on view?
I move on….largely because what I meant is very obvious Fromm what I wrote and I thought the perspective would be too
Yeah, sorry.
I can see why they didn’t get it though, read it (or misread it) they way that they did. I won’t explain because it doesn’t really matter. My point was to extinguish the potential for extended nitpicking with one shot that anticipates all of the angles. Anyhow…
Thanks
It was not my best description
Nor was it wrong
It’s the problem of writing so much without a sub-editor: I accept there are occasions when things are not expressed as well they might be
This all comes down to one thing as far as I can see : striking a balance between creditors and debtors. For the last twenty plus years it’s been a creditors’ paradise largely thanks to government policy here and elsewhere, especially the US , but with the disenchantment of the populace with the status quo comes an alternative yet to be grasped, but grasped it will be in due course . The question is will it be done democratically , or by force. That remains to be seen.
It would be interesting to have a specific and separate inflation target for house prices and rental costs. I propose a target of zero, so that people wanting to get their own property gradually have a better chance of doing so.
To achieve this the BoE would have to keep its operational independence and also be put in charge of issuing planning permissions, and that would be far too radical. And the Tories at the CPRE would be jumping off tall buildings and we can’t have that.