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Inflation wasn’t acceptable in the 1980s

    Today’s bad inflation figures were as expected – CPI inflation is now up to 5.2 per cent with RPI at 5.6 per cent. The Bank of England continue to tell us that deflation is more of a concern, and yet they have now not met their inflation target since November 2009 – 22 months ago. In fact, this time last year the Monetary Policy Committee was telling us that the CPI inflation rate would be just above 2 per cent right around now.

    I have written at length before about the recent forecasting record of the MPC and of who benefits from these above forecast inflation rates. As Allister Heath said at our ‘Reviving the British Economy’ event last night, inflation seems to be becoming acceptable again, with individuals willing to tolerate it as a trade-off for measures designed to inflate our economy out of its current low growth state. In fact, the inflation in itself is immensely damaging both to the economy’s growth prospects and to the Chancellor’s aim of eliminating the structural deficit over the course of this Parliament. Below, I set out five reasons why these figures today are particularly worrying for the Government:

    • High inflation will harm the Government’s efforts to reduce the deficit: the increase in inflation will mean that state benefits linked to it will have to be increased more substantially than they otherwise would have been from April next year. The state pension (£5.31 increase per week for singles, £8.49 increase for couples), the Jobseekers allowance (£3.51 increase per week) and income support will all be upped in line with September’s CPI figures. At the same time ring-fenced areas of spending, such as the NHS and international aid, where the Government has pledged to increase spending in real terms, will evidently now require greater funds. With incomes rising more slowly than prices, it is unlikely that these commitments will be met with significantly greater nominal tax revenues. So for departments with fixed nominal budgets, high inflation means larger real terms cuts  - making it more difficult for the Government to maintain certain public services whilst also cutting the deficit. 

    • High inflation depresses demand and undermines consumer confidence: it is unsurprising that consumer spending is low and business investment is stalling. Stable prices are a prerequisite for both. With wage growth at just 2.6%, real incomes are currently falling by 2.6% per year. According to the ONS, much of the increase in inflation this month has come from fuel bills and increased prices of clothing and footwear. These are both necessity rather than luxury goods, and will mean individuals have less of their incomes left over to spend on other consumer goods and services.  

    • Much of the increased inflation is coming from gas and electricity bills: the ONS explains that the most significant upward contributions to the change in CPI over the past twelve months come from gas and electricity prices – where average bills have increased by 13 per cent and 7.5 per cent respectively. I outlined last month how the bills facing by my own household have gone up from £60 for electricity and £63 for gas, to £83 and £95. There is a huge debate over whether this is due to increased wholesale costs or damaging Government policies. But irrespective of the causes, the public are going to be riled by these huge increases, and it is the current Government who will suffer, particularly if the relative recovery of manufacturing is compromised. 

    • The QE decision just got that bit more questionable: in the Bank of England’s analysis of the effects of the initial £200 bn QE programme, it was claimed that inflation increased by up to 1.5 per cent as a result of the programme. The recent decision to increase QE by a further £75 bn therefore looks particularly dangerous with inflation high and rising. 
    • Older people, more likely to vote, tend to be those most likely to save: high inflation is absolutely crippling savers. With the Bank of England’s base rate at 0.5 per cent and CPI inflation of 5.2 per cent, savers are facing large negative real interest rates. This not only does little to enhance the rebalancing of the economy away from debt and consumption towards prudence and saving, but also harms many pensioners who have saved across their working lifetimes for their retirements.

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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