In this morning's video I note that inflation is always a temporary phenomenon that always cures itself. History proves that. In that case to make it the epicentre of economic management in the UK is absurd. We need much better goals if the country is to make progress, whether on employment, inequality, investment or climate change.
The audio version is here:
This is the transcript:
Why are we obsessed with inflation?
One of the questions that Danny Blanchflower and I will be asking as we work as the Mile End Road Economists is just that because we know that the City of London is obsessed with inflation.
We also know that successive Chancellors of the Exchequer have been.
But the truth is, there's no real evidence that we need to make this the focus of all economic policy, which is what it has become, most especially since the Bank of England was made independent and was given the single goal of controlling inflation as the one and only target it had for running monetary policy in this country.
Let's have a quick look at this chart. I've shown it before on this video series, and I have little doubt I will show it again. Because it is a chart produced by the St. Louis Fed, which is one of the central reserve banks of the USA, but which actually is based upon data from the Bank of England. And it shows the inflation rate in England, and then in the United Kingdom, over periods from 1210 to date. And I do really mean 1210 A.D. It is that long a chart because there has been sufficient data to estimate inflation over that period of time.
Now look at how that chart moves. Every time it spikes upwards, and it does very heavily on occasions, very soon afterwards it shoots heavily downwards.
In fact, the pattern until about 1900 was for a period of inflation to be followed very quickly by a period of serious deflation. In other words, after a period of prices rising, there was a period when prices fell.
Now since 1900, I would agree, the pattern has changed. Quite clearly, we haven't suffered any significant deflation with them. But even so, what still happens is that once we have a period of inflation, things rapidly go back to normal. In other words, the inflation rate goes back to a very low level really quite quickly.
And of course, this is exactly what happened in the period after 2021 when inflation started in the UK.
We had quite heavy inflation during 2022, and for all practical purposes, inflation has now disappeared in 2024.
So there has been complete consistency in the recent episode of inflation with this historic pattern.
The pattern is so consistent in fact we can say this is what always happens.
Inflation is always caused by some form of shock.
In the case of the recent episode of inflation there were two shocks. The first one was reopening from Covid. We know that there were severe supply chain disruptions as soon as the COVID reopening took place because people who had been saving during the COVID era suddenly wanted new cars, new kitchens, new everything and had the money saved up to buy them.
And because they had excess money, because they had been saving, not because of furlough, nor because of the creation of new money, but because they simply hadn't had the opportunity to spend, there was the beginning of an inflation spike.
And that was then exacerbated by Putin invading Ukraine. That led to financial markets speculating that there were going to be shortages of all sorts of raw materials. Petrol, gas, fertilizers, wheat, you name it; apparently, we were going to be short of it. In fact, none of those shortages happened. But, we saw an inflation spike because the financial markets pushed prices up as if there was going to be a shortage, even though there never was one.
And that panic is really why most inflation happens. The shock creates a panic reaction; the panic reaction quickly is normalised because people realise that the panic was unnecessary; the shock is over, and things go back to normal.
Now they don't go back to deflation; in other words, prices don't tend to fall back to where they were, which is the pattern from history, but they always go back to low levels.
So why are we obsessed about inflation in that case?
And why are we making the Bank of England Monetary Policy Committee run monetary policy in the UK as if inflation is the only thing that matters when, in practice, we had no serious inflation at all from about 1995 until 2021?
Now, I'm not saying there was never any inflation risk in that period, but in practice, there was hardly any. And there might well be none for some time to come, until we get another external shock. Even 2008 couldn't create one in this particular case.
So, inflation is not the threat that everyone pretends it is. And in that case, Danny Blanchflower and I will be saying, “Why does the Monetary Policy Committee have the job of running monetary policy, that is the interest rate setting policy of the UK, with the aim of eliminating inflation when, frankly, when inflation happens it goes away of its own accord, without having to change interest rates, and why does it have to do this when there are much greater priorities to address?”
For example, the priority could be full employment. It could be a reduction in inequality. It could be something to do with green climate change because the Bank of England claims it has interest in that subject.
Whichever one of those it is, and full employment seems to be the first and most obvious one, because most other things would follow from that, it would be better than targeting something which is no great threat, and which always deals with itself.
Why, then, does the Bank of England focus on something which, frankly, is almost irrelevant?
Let's look at something much more important is the point we will make, and that something much more important is either full employment or it's investment, or it's the green environment, or whatever you wish. But let's not make inflation our primary goal.
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s always a temporary phenomenon that always cures itself. History proves that. the difficulty with making this argument in a debate is that your debating opponent only needs to name one example and they win
I have presented the UK evidence – albeit I must add the chart to the post.
So you have a chart that shows how FOLLOWING ACTIONS TO CONTROL INFLATION, historically inflation has fallen.
And your conclusion is that no actions are necessary to control inflation? Seriously?
Maybe start with a regression analysis looking at the correlation between reductions in inflation following increases in interest rates, with different degrees of lag. That might give a credible analysis for discussion.
Since when do you think such control has been in place?
And yet it happened anyway?
And you know correlation is not proof, don’t you?
“And you know correlation is not proof, don’t you?”
Correlation DOES NOT prove cause & effect.
This is one of the first principles I was taught in my first high school science class and first college statistic class.
https://xkcd.com/552/
Very good
Funnily enough the one form of inflation that nobody seems to be worried about is Land and Property prices……..
Yes totally this as the majority of bank credit goes into property – surely the elephant in the room that the BOE are deliberately ignoring because the rich are the property owning wealth extracting rentiers and in the last few decades have made untold wealth. Oh and what is the other big destination for bank credit? Isn’t it the stock market/financial sector? More rentier wealth extraction that’s untaxed. I would appreciate some RM critque/analysis on what is clearly a weapons grade state sponsered swindle.
I’m sure that you and your partner in justice will come up with a better answer than me but the obsession with inflation first of all comes from certain economists from a certain school making the argument that it should be a focus and it has traveled rather too well.
But inflation is also a smokescreen – don’t you think?
On one hand, the banks, markets like inflation because it gives them permission to raise prices and interest rates under the guise that it is a ‘crisis’ and that it hits everyone one.
OTOH, it is used to cast a shadow over government spending and wage claims from workers. All those right to buy receipts in social housing were held back for years because the treasury was worried about them creating inflation and have only recently been allowed to be reinvested in the affordable housing stock.
So inflation is a win-win game for capital – it helps them maintain their income streams – taking proportionally more out of the economy than working labour (low wages also means more interest bearing debt for consumption), creating gaps in government spending that can be exploited by private outsourcing and then making more hay when the inflation crisis is actually declared but having the opportunity to place blame elsewhere (wages, government spending etc).
It is – dare I say it folks – a very stable system for those who benefit from it.
Rentiers don’t like it as the real values of other people’s debts, their assets, lost value. If wages rise in line with prices , or even better, with productivity, the employed population becomes better off. This should be the objective of a sensible theory of economics but as Richard says ‘political economy’ is not value free. The two are interlinked.
Hence the neo-liberal or Laissez-faire-policy of keeping down wages. As you say the asset owning class have ways of protecting their position. Even a govt deficit can to be their advantage. The rich buy bonds and receive interest which is a cost to govt balanced by taxes paid by the employed population.
Ian
There is a truth in everything perhaps, and you are right that inflation can eat into people’s wealth – ALL people’s wealth – but the point I make is that the very rich set themselves up to benefit either way with and without inflation – it is a corrupt system as far as I am concerned.
And where the rich win, the rest of us lose in some way in good times or bad times. All wealth creation is remember, is moving money around to an increasingly small amount of people.
PSR
indeed but the system could work better as it did postwar. It needs us to vote a party which delivers it. It should be possible.
Inflation may be important (excluding of course asset inflation), but taxes are much more important.
Ian Stevenson – “The rich buy bonds and receive interest which is a cost to govt balanced by taxes paid by the employed population”. Yes and as Richard D Wolff highlighted in a book on capitalism, governments have replaced their lost taxes from companies over recent decades by borrowing money from the wealthy in the form of government bonds. Company taxes were very significantly replaced with government debt and as such, government control was very significantly replaced by wealth control. The saying that those who pay the piper call the tune has never been truer than now.
https://archive.ph/m1YpA
The UK company tax rate of 52% in the early 1980’s, fell to 19% by 2022 (increased slightly since then but still low historically).
https://tradingeconomics.com/united-kingdom/corporate-tax-rate
‘Last year, the company (Shell) paid $40.5 million in tax from a UK profit of $1.81 billion (2.2%), according to its annual tax-contribution report. Without the government’s new Energy Profits Levy, Shell said it wouldn’t have had to pay corporate tax in the UK’.
‘Even with the UK’s windfall levy, the tax bill was relatively small (sic) compared with neighboring Norway, where Shell paid $2.12 billion in corporate income tax on profits of $3.85 billion (55%)’.
https://archive.ph/IKXNd
Thanks
We don’t appear to understand in this country the game that the rich constantly play which is to dilute the accountability aspect of democracy by the use of quangos and the Bank of England is a quango! Fiscal and monetary authority should be under one authority and that is the Treasury. If they are successful in the guidance of the economy or screw up then at least there is the opportunity to get rid of them fast and especially if the ridiculous fixed term Parliament is abolished and FPTP abandoned which ought to also facilitate rapid change. You wouldn’t run a successful business with the rules this country has imposed on democracy!
“especially if the ridiculous fixed term Parliament is abolished”
I cannot agree with this statement regarding fixed terms for the House of Commons .
Get rid of the ridiculous fixed term Parliament and you would get a bunch of MPs only interested in short term gain for reelection purposes.
Get rid of the House of Lords and replace it with an elected Senate to a fixed years terms and maybe getting rid of if the ridiculous fixed terms for the House of Commons might work.
I tend to agree
“Get rid of the House of Lords and replace it with an elected Senate to a fixed years terms”
More detail:
A fixed term for a Senator sitting in the House of Senators should be a longer term (say 7 years per elected term) than a member of the House Commons. I would also term limit a sitting Senator to no more than an aggregate of 21 years.
The members of the House of Commons would not be term limited as they “should” and usually do, under the UK’s current system, come up for re-election more frequently.
So what happened from the late 1960s, through the 1970s, the 1980s and into the early 1990s (that’s around three decades)? Or was it all a dream?
https://www.inflationtool.com/rates/uk/historical
Inflation came and went, as I said, hindered by monetary policy
I can’t disagree that, in historical terms, inflation comes to an end: “This too will pass”. But, in my case, those 30 years were effectively my entire working life.
An interesting question might be: “Was the post WW2 inflation a genuine exception?” and if so, why?
Also, when long term inflation comes to an end, that too can be painful – endowment mortgages, Equitable Life, split level income trusts?
Sorry, but you are talking nonsense
…Somebody is.
That is no ‘answer’.
@Vincent Barry,
I’m just an interested amateur around here, but looking at the graph, I’d conclude:
– Inflation came and went, for centuries, of its own accord. Deflation offset inflation, so prices rose slowly over the long-term.
– Something changed in the 19th century to curb rapid changes; but it wasn’t what we’re doing now. Prices still changing slowly.
– After WWI, what we’ve achieved, if that’s the appropriate term, is to prevent deflation and slow down the rate of change; hence the “daylight” under the peaks. I lurk a lot, so I know Richard has talked, often, about unnecessary increases in base rate just prolonging the agony.
@ Vincent Barry
what happened..?
Yom Kippur War -> OPEC oil embargoes (you can clearly see the spikes around 1973 and 1979) -> oil prices more than doubled then more than doubled again.
You might even have expected bigger inflation spikes
Despite which, real disposable household income increased because collective bargaining was still a thing, so wage labourers weren’t forced to take the hit.
I commented about inflation around Christmas, when some people seem to comment about the size and prices of tubs of Roses, Quality Street etc, another common one is how people used to be able to get a couple of pints and still have change for a fish supper.
People want to know why prices increase due to inflation, but they rarely want to learn why it increases, and to understand why.
We need better financial education in schools.
Inflation can also act as a tax on wealth and an income to borrowers
In the mid 80’s it didn’t take long for my mortgage to go from 2.5 to 2x earnings
It is a byproduct of magical thinking. If inflation is low then bad things won’t happen in the economy. The same thing can be repeated about debt (perhaps immigration as well). What inflation and debt targeting has created is a political bind that says we cause the bad events to happen if we don’t control them. We are then evil for denying the cause.
The reality is that these things are caused by events and not how I think about them. Rational expectations models are to some degree based on magical thinking. There is 0 evidence to support them.
Do you and Blanchflower agree over the role of the Bank of England?
I heard him on YouTube recently praising Gordon Brown for making the bank “independent”?
Not completely
What we do agree on is the need for its reform and a reduction in the role of monetary policy
Dear Richard,
thanks for this and all of your other posts which I’ve been reading for some time. In fact I read “The joy of tax” years ago which was an eye-opener and taught me a great deal.
The wonderful graph of inflation that you published today clearly shows, to me at least, that govs/central banks have been spectacularly good at solving deflation in the modern era despite all the claims about fighting and curing inflation. The bouts of high inflation which we continue to suffer are hugely damaging without the corresponding periods of deflation but nobody talks or writes about that. I wonder why not?
Cheers
Mick
We are obsessed with inflation because we are told that we should be, and that it is always bad.
Inflation is easy to misunderstand (it’s a increase in prices), because of the way it is explained.
Stephanie Kelton’s next book (not yet published) may address this. It will be called “The Inflation Myth”.
“Whenever inflation rears its head we hear that “it mainly hurts the poor” since their incomes are lower and they are more affected by price rises. This is, at best, half the story because inflation is better thought of as a class specific tax. When “too much money” chases “too few goods” – an inflation – it benefits debtors over creditors since the greater the inflation, the less real income is needed to pay back the debt accrued. …. The politics of cutting inflation therefore take the form of restoring the “real’ value of money by pushing the inflation rate down through “independent” (from the rest of us) central banks. Creditors win, debtors lose. “… MARK BLYTH ‘Austerity’
And the means of reducing inflation do not affect the creditors, but the debtors.
Central banks impose artificial concepts such as NAIRU.
Increasing interest rates deliberately targets the debtors, by creating higher unemployment, and increases instability in employment markets, and by pressuring real wages, with the aim of cutting them. Creditors win, Debtors lose
Correct
Is it possible that the reason prices no Ionger fall again (as the chart indicates they did do historically) is precisely because of deliberate intervention to “tackle” inflation?
You mean, they keep inflation up?
I’m wondering if it’s possible that inflation would have fallen farther or faster without such interventions. I don’t know when deliberate monetary interventions to address inflation actually began. The chart suggests that “modern” inflation began in 1930s, post-depression.
I think it may well have done
The Bank of England has created most current infaltion as a result of too high interest rates
Excellent Richard!!!
I would add that there is a hidden agenda for the inflation crowd – it was an excuse to force independence on central banks – to prevent governments from super friendly rates which help government provide the essentials for the public. The independence ploy keeps government smaller with the ‘government spending causes inflation ‘ lie.
Yanis warns us to be wary of the plutocratic hidden agenda
https://youtu.be/juOd73HDSeE?t=5908
p.s.
There was a severe deflation after WW1 and during the depression.
Inflation gives the private and external sectors the ideal opportunity for price gouging, and they take it as we all know from recent experience. Inflation can be started in a number of ways, but I see it as a sign of economic instability, the supply of goods and services not matching demand (for whatever reason).
It seems to me that interests rates alone are a very poor means to rely upon to control inflation which what we are fed with at the moment. I suggest it is important to understand the initial cause and either correct the problem or introduce controls to minimise the problems, using fiscal and/or monetary measures (whatever is apprpropriate for the situation). The current belief that raising interest rates is all that is required seems both wrong and simplistic.
(I have no answer to the question as to how price gouging can be stopped.)
Why do we obsess about inflation?
Simples.
The wealthy folk for whom our world is nurtured and designed fear that inflation is eating away at their stash of gold and that is very worrying. (Having as stash of ‘gold’ is in itself a cause for worry)
For those with debt to service inflation is a godsend as long as wages increase in line. When `I was a lad in my twenties the older adults with mortgages were paying a pittance thanks to the inflation of the seventies. Without inflation mortgages are an immense burden. These same adults are probably now obsessing about how inflation is undermining their holdings of wealth. Those who are still alive.
We have short memories of the advantages we had and begrudge them to the up-coming generation because we feel we worked for what WE have. All tosh really isn’t it?
You are very largely right
If you give a child a hammer (or indeed give a man a hammer) as the only tool in his toolbox he will use it to hammer things whether they need hammering or not.
The BofE has the hammer of interest rate setting and it’s all they can do. So they do it.
If Rachel Reeves were a responsible parent she would have put the hammer in a safe place.
She isn’t. So she didn’t.
There is a video coming on this…
“ The Bank of England has created most current inflation as a result of too high interest rates”
That’s a very bold and provocative statement, with absolutely zero evidence to support it. Even a first year A-level student would be expected to provide at least some basic justification as to why it might be true.
Some might expect a basic credible analysis or even a vaguely compelling argument from someone who claims to be something of an economist.
Of course you can say whatever you want on here and no-one will challenge you, your sheeple will lap it up as if it’s true and accurate. Which it most certainly isn’t.
This blog is a narrative.
It’s continuous.
I have explained the argument many times before, as have others.
Most inflation on. Now is caused by rent increases and other price rises that reflect implicit interest charges.
It really is not very hard to work out, but my out could not manage it. Abuse is your stock in trade.
Blair Fix has nicely skewered the myth that high interest rates cause lower inflation (https://economicsfromthetopdown.com/2023/02/04/do-high-interest-rates-reduce-inflation-a-test-of-monetary-faith/ and https://economicsfromthetopdown.com/2023/03/02/the-key-to-managing-inflation-higher-wages/). He shows how the same misuse of statistics can be used as evidence that increased CO2 levels REDUCE global temperatures. I have just had something on this published in Sussex Bylines (https://sussexbylines.co.uk/business/economy/the-perils-of-using-interest-rates-to-control-inflation/). If any process is cyclical and it causes something to happen, you can show a highly significant correlation between the side effect and the future level of the cyclical process.
The paradox is that keeping interest rates artificially high is giving an inflation-busting pay rise to those with money to spare, at the expense of those who need to borrow.
It’s true that as inflation increases the value of the wealthy’s money decreases BUT and this is a major but, the wealthy nearly always tend to have assets that also increase proportionally far more than inflation. Property is an obvious one that has traditionally inflated faster than FIAT currency. But stocks and shares are also common assets that inflate faster than FIAT inflates.
That’s why if you are rich you’d be stupid to save all your money as FIAT in a savings account. You’d use it to buy assets that appreciate at a rate more than inflation. So when inflation happens your assets soar in value.
And all the research has shown is that high inflation doesn’t tend to stop the wealthy from spending because they have more wealth from inflated assets and then they spend it which increases inflation. The wealthy consume far more per person than the less well-off. Their consumption habits lead to higher inflation for the rest of us.
The wealthy don’t fear inflation, they embrace it.