Inflation has been dead and buried for such a long time that, collectively, we may have forgotten why it’s such a big problem. There are three primary reasons why, now that it’s back, we should worry. First, it is a deeply unfair process. Second, it creates uncertainties about what things really cost, clouding our ability to know what’s really going on. Third, our leaders — the politicians and the central bankers typically tasked with controlling inflation — don’t always see eye to eye on how inflation should be brought to heel.
Inflation is unfair for the simple reason that it acts like an amoral version of Robin Hood, stealing from some even as others are rewarded. If you’re a poor pensioner with savings mostly in the form of cash, the chances are that you’re going to lose out: over time, your savings will be worth less and less in “real terms”.
If you’ve got a big mortgage and you’ve fixed your interest rate for the next five years — thus protecting you from any further rate increases from the Bank of England — the chances are that you’re going to win: inflation pushes prices and wages up relative to the amount you initially borrowed to buy your property.
If you’re young, qualified and interviewing for jobs in London, you may be about to do rather better than your predecessors. According to the latest KPMG REC survey, 59 per cent of London employers had to increase starting salaries in January, the highest figure recorded since the survey was first carried out 25 years ago.
Meanwhile, inflation creates uncertainties that make many of us poorer than we might otherwise have been. Should a company still invest even if interest rates are heading higher? Maybe yes, if it can raise prices to offset higher borrowing costs. Maybe not, if its other costs — wages, raw materials — are rising faster still. The chances are that the company will postpone its decision in the face of excessive uncertainty.
Higher inflation is typically more volatile and, as such, makes it tricky for any of us to gauge what is really going on. Even TfL can’t be sure: the rise of about five per cent in bus and Tube fares may have been designed to be “inflation-busting” but, with current inflation at 5.4 per cent, Sadiq Khan may still find himself short of “real” cash, even if the rest of us are paying more to travel.
And inflation leads to profound policy disagreements. Only the other day Andrew Bailey, the Bank’s Governor, urged wage restraint, fearing the return of the wage-price spirals that plagued the British economy in the Seventies. Immediately, Boris Johnson’s spokesman criticised Bailey’s remarks, noting that “we obviously want a high-wage, high-growth economy, and we want people’s wages to increase”.
No more than a minor spat, perhaps, but the competing views emerging from Threadneedle Street and Downing Street reflect differences with regard to history as well as plain old economics.
Let’s start with the economics. It would be lovely to have a “high-wage, high-growth” economy, but you don’t get the latter simply by giving everyone the former. If wages double, say, then either companies will go bust or, more likely, prices will double, in which case nothing “real” has happened.
In aggregate, meaningfully higher wages are most likely to result from producing meaningfully higher output. That only happens if we’re collectively more productive — typically by embracing new technologies or building closer connections with trading partners. Tackling productivity, not simply paying higher wages, has to be the priority.
An historian by training, Bailey is also old enough to remember the Seventies well. He doubtless fears a repeat of the wage-price spiral that took hold back then. However, the lesson from the Seventies is that you can’t easily keep a lid on inflation simply by asking for price or wage moderation. Those who’ve already got their pay increase or who have received a bumper increase in profits will simply say “thank you”. Those who’ve been left behind will have a strong sense of grievance: see how people responded to his observations.
That is where monetary policy comes in. If there’s an understandable distaste for prices or incomes policies, the alternative way of “anchoring” inflation is via changes in interest rates. That, in effect, is what the Governor is telling us. We can demand higher wages. If, however, inflation rises further as a result, there will be a monetary price to pay: interest rates will head even higher. I wonder if Downing Street has got the message.
Stephen King is HSBC’s Senior Economic Adviser and author of Grave New World
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