- It’s no way to run a countryPosted 5 days ago
- The extraordinary political power of unelected central bankersPosted 11 days ago
- Should savers be scared of big, bad Canadian wolf Mark Carney?Posted 20 days ago
- Warning: low interest rates are seriously damaging your economyPosted 26 days ago
- Trust me, I’m a politician!Posted 36 days ago
The inflation myth
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.