The inflation myth

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Although it may pretend otherwise, the Monetary Policy Committee has a remit, set out in the establishing Bank of England Act of 1988. Section 11 reads:

 In relation to monetary policy, the objectives of the Bank of England shall be –

(a) to maintain price stability, and

(b) subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment.

Yet inflation has been above the Government’s 2% target in 41 out of the 47 months since Bank Rate was cut to the record low of 0.5% and QE began. Indeed, it has been above 3% in 28 of those months, reaching 5.2% at one point.

In seven years, inflation has been below target in only 10 months and Mervyn King has been compelled to write 14 quarterly letters of explanation to the Chancellor.

Given this utter failure of the MPC to stick to its clearly stated remit, it is outrageous that the Bank and Mervyn King have just blithely announced that inflation will rise still higher than this and remain above 2% for at least the next two years. Naturally, King claims, as so often, that inflation will fall to the target “in the medium term.” This so-called “flexible” inflation targeting is surely an erroneous reading of the Bank’s statutory remit.

Inflation is a tax in all but name

Inflation erodes the value of our money and means that our income buys less. Inflation is a tax in all but name and explains why the ONS has just revealed that real incomes in Britain are at their lowest in a decade.

Since March 2009, the CPI index – which should have risen less than 8% – has climbed 13.8%, while the ONS Pensioner Price Index is up 17%. The MPC often claims that price rises are due to circumstances beyond their control. Yet while prices are often affected by short-term supply shocks, most economists acknowledge that inflation is a factor of how much money is injected into the economy. In the early 70s, the broad measure of our money supply was £34bn. By 1997, it was £700bn and it tripled to £2.2 trillion by 2010. The authorities have become addicted to printing money but it is us who will suffer the withdrawal symptoms when it all goes wrong. Thank goodness that, for the present, the banks are sitting on much of the extra money.

We tend to look at inflation as a rise in prices. But it may make more sense to regard it as an erosion of our purchasing power. According to RPI figures, the value of the pound has declined by over 95% in my lifetime. It’s a shocking erosion of the value of our currency and yet it remains generally accepted that a bit of inflation is no bad thing.

Inflation may massage headline numbers upwards, but it does not create growth, just as printing money cannot increase overall wealth. Economists talk of inflation as if it affects everybody equally, but that is far from being the case. Those nearest the source of new money, particularly people in the financial community, suffer least from inflation while those at the bottom of the economic heap are most disadvantaged. Those who are no longer earning, but living on fixed incomes, are hurt most severely of all.

Inflation is a transfer of wealth from savers to borrowers. It erodes capital but also, crucially, it erodes the real value of debt. With the government the biggest debtor of all, owing an eye-watering record £1.1 trillion, perhaps we should not surprised that the Chancellor has not given Sir Mervyn King a sharp rap on the knuckles.

Is deflation really such a bad thing?

The Bank’s video explanation of Quantitative Easing says that “without that boost… inflation might fall below target”. Does anyone really still believe that inflation might fall below its target? And given that 2% is the level around which inflation should be anchored, why is it a matter of shoulder-shrugging for inflation to be above 2% but utterly terrifying to countenance a period when it falls below it?

The MPC is determined to avoid deflation at all costs. They believe that if prices fell, consumer spending would grind to a shuddering halt. It is a ridiculous notion but shows as much understanding of human behaviour as the belief that lower interest rates would persuade all savers to go on a spending binge. Technological progress and improved productivity mean that many prices SHOULD decline over time. Indeed, we are used to that being the case with technology and consumer durables, as illustrated by the graph.

Adjusted for inflation, my first laser printer cost over £11,000. I can now buy a better machine for under £50. Do people cease to buy things because the price might be lower in the future? Of course not. If anything, you could argue that this might make people replace products more often, boosting consumer spending. Mild deflation would, from the savers’s point of view, be a godsend, as the real value of their capital would steadily increase.

But while we have deflation in some areas, inflation elsewhere is endemic, particularly with the essentials of life. It undermines saving and thus capital, which in turn inhibits investment and growth. Inflation is not caused by rapacious supermarkets, inefficient farmers or greedy oil companies. It is caused by the supply of money in our economy growing more quickly than the goods and services that are available for that money to buy.

Like all major countries these days, we have a paper, or fiat, currency backed by nothing but the word of the Government and our central bank. But the phrase “I promise to pay the bearer” means less with every passing day. If a ten pound note had shrunk over my lifetime in line with its purchasing power, I would need a magnifying glass to find it in my wallet.

Inflation is not the answer to anything. It is the problem. The Monetary Policy Committee was set up to keep inflation bottled up. They have failed in their job. And they have just admitted they will continue to fail for at least two more years. Having a target they continually ignore undermines the credibility of the MPC and the Bank of England – if they have any left.

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6 Comments

1. Dave

   February 15, 2013 at 1:26 pm

   The only answer you will get from the MPC and the government is “if we didn’t do what we are now doing then things would be much worse”

   They don’t actually know that of course, and it’s a really stupid answer that could be used to apply to just about anything about everything:: “if I hadn’t thrown that custard pie in your face Sir it would have been much worse as someone else would have thrown a brick”

   Recommend (12)
2. frances

   February 15, 2013 at 1:46 pm

   For all the Pensioners like me whose majority of income derives from Savings interest things have got so bad we are likely to spend the rest of our lives dependant on Pension Credit

   Anyone who thinks they can live on 142 pounds a week please sign in here
   Mervyn King is sitting pretty on 1/4 million a year Pension while he has destroyed the lives of pensioners who went without their entire lives to SAVE FOR RETIREMENT
   As for George Osbourne and all his cohorts at the treasury they clearly cannot add 2 + 2 let alone pass GCSE Maths

   Recommend (12)
3. gareth

   February 15, 2013 at 5:10 pm

   I feel so much for savers like Frances – whose comment is above.

   MP’s and those at the BOE – who will all ultimately receive inflation linked final salary pensions at our expense – have no comprehension of how the steady erosion of interest rates have decimated savers returns and made real differences to their way of living.

   Savers are often not rich people.

   Often they are just normal responsible people who have saved where possible in order to be independant of the state, improve their lifestyle and perhaps provide smal inheritances for their offspring.

   I expect savers tend to be older, perhaps having lived through or soon after WW2 and learnt or been taught by their parents to be careful with money, to make it go far, to make it last, to be prudent and careful.

   Unfortunately this way of living is out of fashion – the young have been spolled with years of cheap credit and have adopted the exact opposite way of living – max out on the mortgage, credit card, overdraft

   Its is an absolute disgrace that savers are being so dis-respected by the government.

   Unfortunately because of the nature of the typical saver – tending to be older, of the WW2 generation when you did not complain but just got on with things – they are not inclined to complain or to make as fuss.

   This is disappointing because if they were to be more vocal and complain and make their complaints heard, they actually have a voice that the government, particularly a conservative one, would have to listen to – their voting power is significant.

   Recommend (16)
4. BOB

   February 15, 2013 at 9:50 pm

   I am going to remind my self who got us into this mess in the first place.
   Labour Government , spending like there was no tomorrow,totally out of control ,no planning,no fail safe system to call a halt on spending once the balance became
   dangerous ,lack of basic house keeping skills/no common sense /bad management , no experience in large project decision making, ect

   Bankers. /or should i say sheep. lets pile in like the others,buy up as much U.S mortgages as possible even tho the purchaser can hand the keys back at any time
   and walk away, even tho the housing market bubble is so large ,every body knows it’s about to burst.except the bankers.never mind it’s not our money.bad management,
   no forward planning protection system in place, kids playing with monopoly money in millions, managers turning a blind eye to dodgy dealings,ect

   And who has to pay for a large part of this balls up us savers/retires/ pensioners/young people trying to save for a deposit. the whole country all due to greed and a lack of
   control and planning by governments and banks ,plus a few other organizations ,This government has bent bent over backwards to boost the banks coppers and wan’t be happy until they got millions in the kitty ,mostly as savers costs, even tho the buggers caused some of the problems we face today. well thats how i see it as a layman.

   Recommend (5)
5. Anne

   February 16, 2013 at 2:07 pm

   The downward spiralling of our economy through hyper-inflation and exceedingly low interest rates and low wages, is a deliberate policy put together hand-in-hand by the government,the mpc,the chancellor and the governor of the bank of england. It is a policy that will never go away as long as these ministers hold their positions and continue corrupt practices. It is a new and additional way of taxing people,in order to get as much money out of us all,as is possible. This is to pay for our membership of the EU,which comes at no cheap cost.We sir,are the mugs. They sir, are the criminals. When everyone`s money has disappeared in to the government coffers,where do you suppose,they will turn?.There will have been no growth in our pockets and no growth in the economy as a result. They are heading,for certain towards bankruptcy. Perhaps this is the plan. Would this surprise you? It shouldn`t. Meltdown is on its way.Why doesn`t someone kick them out NOW?

   Recommend (8)
6. John.

   February 22, 2013 at 5:43 pm

   BOB

   Seriously, the current banking and credit crisis stems from Reaganomics and Thacherite banking and housing deregulation which unleashed the city speculators, shackled local authorities and spawned an army of money for nothing slum lords. Labour were just another bunch of idiots in a long line caught carrying the bomb when it went off, that said the war criminal Blair seems to have come out of it rather well with his Zionist payoff for helping to destroying I-raq.

   The housing boom was and is an illusion built on speculation and unsustainable debt. It’s also the only tangible thing the banks have left to cling on to which is why they’re making sure everyone else pays to deflate their debt bubble.

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