The obsession with inflation that is dominating UK economic policy at present has some justification, but only if the proposed remedies are better than the situation that might exist if no action on inflation was taken.
As I have said repeatedly, the option of taking no action on inflation is always possible. Inflation does not, contrary to claims made, usually become embedded in an economy unless other circumstances exist.
For example, it might have become embedded in the US in the 1960s, but trying to fund and fight the Vietnam war fuelled demand in that country beyond capacity limits, and inflation resulted. Such situations are, however, rare.
Those rare exceptions apart, inflation is a reaction to an exceptional shock within an economy and like all shocks, the after effects fade with time. We have had three such shocks (Covid reopening, war in Ukraine and Brexit) and only one remains now. The effects of everything but Brexit should be fading now which is why inflation is falling.
In that case any intervention has to achieve three goals. It must end inflation earlier than it would have done. It must reduce its impact on those most vulnerable to its impact. And it must not create new issues. You can suggest other conditions. All will, I suspect, be variations on these themes.
Whether raising interest rates at this moment has reduced the time period over which inflation will be suffered is open to doubt. Because all major countries are raising rates we have no control case with which to compare outcomes. So the best that can happen is that we compare what is happening with what the likely movement in the inflation indices would have been with no intervention.
Inflation indices are pretty crude mechanisms. In effect, what happens is that prices one year are compared with those a year earlier. But the reality is that inflation is calculated monthly with an index movement announced at monthly intervals. So, when the June 2023 inflation rate is announced what happens is that the June 2022 monthly change in inflation is knocked out of the annual index calculation and the June 2023 monthly change is added in its place. If the June 2023 figure is smaller than that for June 2022 then the annual rate of inflation falls. If it is bigger it rises. It's that hard to work out.
Precisely because the index works like this it was possible to predict with considerable accuracy that indices would increase until about the time of the first anniversary of the war in Ukraine, with all the price shocks it created in 2022. All of those price rises are now falling out of the index. The impact of Covid reopening has now passed. World trade prices in raw materials and commodities are now largely at pre-war levels.
It was not hard to predict as a result that the inflation index should have fallen heavily this year. I did. So did the Bank of England. Rishi Sunak gambled heavily on it, promising it would happen. And right now it is not clear that it is. Inflation is much stickier than it should be. Something has going wrong in that case.
The question to ask then is whether the measures taken to control inflation are part of the reason why inflation is not falling as fast as expected? The answer is that, of course they are.
As the IMF noted yesterday, the biggest cause of inflation stickiness now is profiteering. Some of that is reflected in higher import prices - although those should be falling rapidly now - and the rest by increased profit taking. Some of that is by companies increasing prices by more than costs have risen, with Primark being the latest to admit that it was doing this yesterday. But a big part, I suspect, is explained by significant increases in bank profits as they earn more from central governments whilst simultaneously not passing ion the benefit of interest rate rises to savers. Put simply the cure for inflation is now, in my opinion, making matters worse.
But there is another dimension to this. That is that the supposed cure for inflation, which is made up of upward interest rates and downward pressure on wages, all backed up by a programme of quantitative tightening to ensure interest rates rise, is also designed to make the impact of inflation very much worse than it need be.
Inflation is bound to make life harder for a number of groups in society. The first such group are those on relatively low and relatively fixed incomes. Pensioners, the elderly and many employees on lower wages are in this group. State benefit indexation might protect some, but it is very apparent that many others are now at a tipping point because of the denial of fair pay rises.
Then there are borrowers, where the impact is heaviest on those who combine borrowing with limited wealth. That best describes young homeowners with very high borrowing to value ratios on their properties. They might enjoy a relative fall in the real value of their debt, but if their debt servicing costs rise significantly in a way that simultaneously increases their immediate costs without any additional income to match that rise, and as a result house prices fall (as is happening in both real and absolute terms right now) then they are hit especially hard.
The third group is lenders. Whilst the income on their loans might rise with increasing interest rates, the real value of those loans fall, and they use their financial clout within the political economy to try to prevent this.
Interest rate rises only help line of these groups. That is the last.
Wage suppression for those on low pay helps none of these groups. That's easy to see in the case of the first two groups, but the risk of default also rises for lenders. So pay suppression exists solely at the whim of deluded politicians who do not realise the cost they are creating and who are obsessed with government debt without appreciating that inflation always erodes its value, which fact they fail to take into account.
Using this analysis there are almost no winners from the approach to inflation management adopted now. There are, however, plenty of losers.
The losers are those already worst off because of low pay and inequality.
The losers are also predominantly young, because they have the highest overall rate of borrowing in proportion to wealth.
The losers are the public services, for whom people can no longer afford to work.
And then there are the losers we do not see immediately. They, mostly especially, include developing countries forced to borrow in currencies other than their own. The likelihood of another global debt crisis having a massive impact on the global south is now very high.
After that, the impact is on climate change, where the measures taken make it likely much less will be spent on the transition we all need.
So, in summary, it is unlikely that any of the measures taken to tackle inflation have had much, if any, beneficial impact. They could instead have made inflation and its impact very much worse. And what they most definitely have done is made the well-being of those who any policy on inflation should seek to protect considerably worse.
And you wonder why I am angry about the incompetence of the Bank of England and those politicians from all parties who support them? You shouldn't be: they are failing us very badly.
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My pubic sector org’ has lost 4 tradesmen this week to the private sector where pay is higher but not 10% for working people – I’ve had a pay rise last year but have just been given an honorarium to replace a senior manager who has just upped and left and short notice and to finish his work. We’ve been hemorrhaging staff for two years.
All this stuff could have been dealt with years ago by not inflicting austerity from 2010.
So employer’s are panicking and trying to retain where they can. I’m recruiting a much needed member of staff whose post has lain empty on the establishment for two years but I’ve had to regrade a grade higher to get interest.
All the Tories have done is create a market of chaos. If they thought that BREXIT would stop immigration and then wanted non-immigrants to work at immigrant rates of pay, they were sadly mistaken.
This is an expensive country to live in, and the Tories (and maybe Laboured) think they can just turn it into a modern slave state.
Well, they’re wrong. I don’t think people are standing for it.
So, much of the behaviour of the inflation index is an artifact of its being calculated over a period of a year. If it were calculated over a longer period then the effect of an external shock would seem smaller but it would take longer for it to work through the system. Conversely if the period were shorter then the effect of the shock would seem greater but it would work through the system faster.
Bernard
The shock associated with inflation is not seeing the % figures covering whatever period of time, it is paying the higher prices in order to live, or run a business. That shock is felt every day unless there is a concomitant increase in wages (to live) or prices (to run a business).
I increasingly wonder if the % ‘inflation’ figures that are used are not yet another meaningless figure designed to confuse the public. They do not represent the increased cost of living for most people because of the ever-changing basket of goods and services used. For those on the very lowe4st income, vurtually all their money is spent on food and energy. The price increases in those are well above 10%, but the increase in their5 income is based on the inflation figure aren’t they lucky, they got an increae in line with inflation, but they can afford to buy less and less.
This is undoubtedly true
Another factor is travel?
Getting around anywhere in this septic isle is bloody expensive, leading to more pressure on budgets amd leading to more social isolation no doubt.
It’s a rentiers paradise this place at the moment, and what with the markets ‘adding value’ like nothing before, we are in a perfect world of exploitation.
Informative as ever Richard. I wondered if you had read Coppola’s response to the IMF report in which she says argues that rising profits are a symptom of inflation and not a cause; she says:
“Rising corporate profits are a symptom of excessively strong aggregate demand. And so is inflation”.
…..and….
….”as long as most people have enough money to absorb higher prices without cutting consumption significantly, inflation won’t fall”.
I have to say I find her reasoning tautological but wondered if you had seen it?
Alan
She blocks me from reading her stuff
I certainly won’t pay fir it
And if she really thinks the economy is overheating she’s stupid, like all the other economists who claim this
Hi Alan,
Surely depends on how the increased profits were derived.
If Evil Corporation sold 2 widgets instead of the previous one, at same sales prices, rising profits are indeed demand-derived.
However if Evil Corporation sold one widget but at double the previous sales price (say no change to unit cost to avoid getting into cost accounting), rising profits are a result of the decision to raise sales prices. Whether that could be described as “profiteering” would depend on the evidence, although I did say no change to unit cost which does indicate some ‘excess’ profit taking perhaps.
Frances Coppola cannot say that increased profits can only be due to increased demand. There is no evidence for it. I’ve looked up her statements on the T-word and, as someone pointed out, she appears to be ideologically opposed to admitting that Evil Corporation (and likeminded friends) could ever engage in profiteering.
Her argument appears to be based on the simplest notion of economic theory, that prices respond to demand, without admitting any nuance due to elasticity or monopolies etc.
As I mentioned in a separate post addressed to Richard today, there were no periods of negative inflation recorded in the UK between 1960 and 2015, so the idea that prices fall in relation to falling demand due to people having less spending power might work in O level economics theory textbooks – in its simplest form – but it does not seem to be borne out in practice in real life Britain between 1960 and 2015, unless of course wages outstripped inflation during that period (bolstering demand), which I’d have to be shown hard evidence of in order to believe.
She seems to imply ‘wages plus savings’ being enough to hold up demand despite rising prices, yet I fail to see that the British public could possibly have drawn down their savings for 55 years to make up for ‘inflation minus wages’, unless of course inheritance is included in savings in which case Coppola’s excess demand is being driven by us inheriting our parents’ assets (houses, probably) and then spending the proceeds. Possible? But still does not exclude profiteering.
If that were the case, that demand is being tipped into ‘excess demand’ by savings derived from inheritance rather than earnings, then inflation would not be caused by “greedy” workers asking for pay rises but rather by rising asset prices. All right for those who have assets to inherit; not so for those who don’t. House price inflation actually feeding inflation, both house price- and non-.
There only ever appears to be one go-to solution for applying downward pressure to inflation, raising interest rates, but this is ever so crude, as I’m sure Richard has gone over many times, with great vigour. There must surely be other more nuanced methods of attempting to apply downward pressure on house prices. I recall some vague mutterings from the BoE, I think, a few years ago, in terms of looking at alternatives but nothing seemed to come of it. The BoE does seem very set in its ways, and/or very limited in its scope for action, and of course will have overall targets to achieve. If those overall targets are met, they get a pat on the back from the government, even if the rich have become richer and the poor become poorer in the process.
I was late to the party on Richard’s broadside against the independence of the BoE yesterday. The way I see it, an independent BoE has no mandate to look after the poorer echelons of society, and yet the Tories have no interest in looking after them. The poor would seem to lose out under either system, assuming Tory government, which is pretty much a given in post-war Britain, bar those heady ’90s days of Cool Britannia and Golden Brown.
Much to agree with
Thank you
I think Frances Coppola’s grasp of economics rather basic, as you suggest
If you think about it both Covid, Putin’s invasion of Ukraine, and Brexit are all wars and these cut-off old connections in trade and finance and usually develop the need for new ones. As far as finance goes this is likely to result in the creation of additional credit and none more so than state created credit to tide a nation over a period of uncertainty. There is no appreciation of this of course amongst politicians subscribing to the Neoliberal Death Cult understanding of money!
“Because all major countries are raising rates we have no control case with which to compare outcomes”.
Except Japan?
And they don’t seem to be suffering anything like as much.
But the social profile of the economy is also fundamentally different
See some info on Japan
https://billmitchell.org/blog/?p=60938
I never read Bill Mitchell
Why would I read someone who has no political economic antennae?
A couple of thoughts:
I would have thought that the statisticians could come up with an extrapolated (and seasonally adjusted) annual equivalent inflation rate every month, from that month’s figures, at least for those who are bothered about such things, rather than just relying on the comparison with a year ago.
Apart from the ‘supposed cure’ of raising interest rates and pressing down on wages, what other actions (are there any?) might the BoE/government take to counter inflation?
Biut they don’t…
Hi Richard,
Please could you confirm or correct the following understanding of inflation, based on hypothetical average annual inflation for a few years:
Y1 average of inflation = 0%
Y2 = 10%
Y3 = 0%
We might surmise that in Y2 there is a shock to the system causing prices to rise rapidly e.g. a war. It’s a shortlived war that miraculously ends during Auld Lang Syne at the end of Y2. A hungover British public wakes up on New Year’s Day (or the 2nd if it was a really big night), sees the news about the war ending, and confidently expects inflation over Y3 to be minus 10% thus bringing prices of stuff back to the pre-war level of Y1. There was a war, stuff got expensive, stuff came down again, everyone is very forgiving that these things happen, nothing to worry about long term.
But that doesn’t happen. Inflation for Y3 is 0%, meaning the price of stuff post-war never came down (and indeed it doesn’t come down below 0% going forward, let’s say).
That shock-derived inflation for Y2 has effectively been baked in. It is a permanent 10% reduction in people’s ability to purchase stuff, but because Y3 inflation is broadcast on the telly as being 0%, the country is lulled (some might say tricked) into thinking prices are back to being as affordable as Y1 again, after all what could look more attractive and affordable than inflation of 0%?
This appears to be what happened in real life in 2022? There is no period of negative inflation to bring us back to where we were pre-Ukraine? There is in fact a permanent shock to people’s wallets, let’s say of around 10%, which is why people feel significantly poorer and are increasingly lacking in trust in the headline figures – and rightly so – but can’t quite put their fingers on why.
A quick google reveals that there are almost no modern day examples of negative inflation in the UK. There was one in 1960. The next one was minus 0.1% in 2015, according to the Guardian. So, not one period of falling prices recorded for 55 years. I find that extraordinary and quite alarming. It’s a real kick in the teeth for the theory that prices will fall if demand for goods/services falls.
This means – I believe – that the British public should be way more concerned/terrified about inflation figures of 10% because history indicates that that figure will be baked in. There is no evidence for “prices will go up but prices will come down again”. They don’t. They go up and then they stay up. So if inflation is 10% and you are being fobbed off with a 5% pay rise because “Prices will come down again next year so we don’t need to give you 10%, how about 5%, let’s be reasonable here”, you need to hold out for the 10% because if you don’t then you’ve lost 5% of your purchasing power and you’re not getting it back again (all things famously being equal).
If politicians or employers or media figures (etc) then claim that workers are being somehow “greedy” or “reckless” by demanding their wages keep pace with inflation, any such accusations can only be mendacious, exploitative, and completely immoral in nature, attempting to take advantage of workers not understanding the absolute necessity of protecting their pay packets against negative shocks that are NOT temporary in nature but in fact permanent?
Thanks if you can find time to reply.
Your analysis is correct and appropriate, as are your concerns.
I can’t add much. You hit the target.
That’s just it! I’m really no economist but thanks to the good side of the Internet, I’ve found great sources of information, of which Richard is one that help me understand what is really going on. I work in education and I’m seriously asking colleagues to look at embedding these discussions in their curriculum. It’s so important. Lecturers in Scotland have been on ASOS since May without much coverage, and being told there is not enough money in the system, however im now able to stand and dispute this and happy to fight the fight, thanks Richard
Hi Lucy,
Not sure if you’ll see this, but is this kind of stuff not spirited away within the Scottish curriculum somewhere? No?
There used to be something called ‘General Studies’ in English schools – what could possibly sound more alluring? – when I were a lad. I imagine some very basic ‘how the country works’ stuff was involved. I did economics so GS is now just a blur. I wonder did I even turn up to it.
Ireland until recently had something called ‘Civics’ (CSPE: Civic, Social and Political Education). It was removed from the curriculum a few years ago but is still taught as a non-examined subject.
I only know ASOS as some kind of online shopping site. I understood you’d all gone shopping online. Imagine how furious the parents would be. And the Daily Mail. So I’d fully support you.
No education professional wants to deprive his or her students of a day’s classes. So it’d be really nice if the students and their parents came out on strike to support the educators, instead of the educators having to go on strike themselves. That, to me, is the way it should work, if the public were disposed to value their educators instead of seeing them as objects of lifetime grievances.
I think Francis Coppola’s and Simon Wren Lewis’s point was a little more nuanced. If companies are profiteering it must be because people are paying the inflated prices. For some goods energy and food they may not have any other option but for Primark goods the do. So the question is for those who are paying inflated prices for non discretionary goods where do the get the money? Running down savings and increased credit cards spending are obvious possibilities
That people are paying the excess prices is indicative of market power
And disposable consumption is down 7% is the answer to your second point
Grateful thanks, Richard, for calling attention to the fact that the people of the Global South are suffering from the current approach to inflation management.
Indeed, I would say that there is already a global debt crisis causing massive damage to the Global South: by the reckoning of Debt Justice campaigners, 54 of the world’s countries are now in debt crisis – up from 31 in 2018 and 22 in 2015 (https://debtjustice.org.uk/countries-in-crisis).
They are right to say so
This is a massive crisis coming
Even Jeremy Warner in the Telegraph, hardly a left winger and someone with whom I seldom agree, yesterday agreed with you that raising interest rates is raising inflation. He said,
“In other words, raising interest rates may add to inflation as much as subtracting from it by depressing demand. Once inflation gets a grip, it’s very hard to get rid of.”
When he and you agree there is probably some substance to it.
I wonder where he got the idea from?