The main measure of inflation is stuck at 2.7 per cent in November with food prices and higher energy bills helping keep it at these levels. As we’ve seen for quite some time now, wages are also stuck some way behind, growing only 1.3 per cent at the last count. It’s not the best Christmas present as it means the amount households have to spend is gradually eroding over time. I’m afraid the indications are that this pattern will carry on into the new year: only some of the energy bill hikes are included in the latest numbers and bad weather at home and abroad means harvests are poor, so food bills will continue to edge up.
Labour warns that the Government is heaping on pressure just when it should be easing off.
Meanwhile, the Government points out that inflation is still almost half the level it was at its peak last year and insists the Chancellor is doing what he can with “a further increase in the tax-free personal allowance and cancelling the fuel duty increase that was planned for January.”
When times are tough and you’re counting every penny, a drop in your spending power of 1.4 per cent in real terms (wage growth minus inflation), or worse if you are on benefits, will matter – especially over time as the effects build up. But inflation is far from the highs it reached in the 1970s and 1980s. Has the beast been tamed?
Some economists think it has and that the real threat is the lack of growth in the economy. Despite the Bank of England cutting interest rates to record lows, despite amplifying that with quantitative easing and despite the joint effort with the Treasury in the Funding for Lending Scheme to stimulate the economy, nothing has yet worked and Britain is stagnating. The Bank’s hands are tied as its only official remit is keeping inflation in check – at two per cent (something it hasn’t quite managed to do for some years now).
Should the Bank ignore inflation for a while and instead unleash even more radical measures? The current leadership at the Bank is loudly opposed and targeting inflation is its creed. But the man who has been hired to become its next governor, Mark Carney, mooted other options last week. They give us clues to what may happen when he takes over – especially as the chancellor said he is open to the ideas.
While at the Bank of Canada, Mr Carney has long advocated “flexible inflation targeting,” in other words allowing considerable time to bring inflation back in line after the recession – far longer than the Bank of England. This means not raising interest rates as quickly as they might so that the recovery isn’t killed off before it can get going.
Mr Carney was the first major central banker to give guidance that he would keep interest rates in Canada low for a specific period – again something the Bank of England currently opposes, explaining that it can’t know what conditions will be tomorrow let alone in a year’s time. The argument from Canada is that it gives householders and companies an incentive to borrow now, fuelling the recovery. The US central bank, the Federal Reserve has done something similar, if even more radical, committing to keep rates low until unemployment falls from 7.7 per cent to 6.5 per cent. Again, this could be tried in the UK.
One step further still (and what Governor Carney told me last week was the logical conclusion to these thoughts) is abandoning inflation targeting and instead aiming for growth in the economy. It’s called targeting nominal GDP growth and allows the bank to focus on growth and not worry (initially, at least) about boosts to inflation beyond its control, like a rise in oil prices because of tensions in the Middle East. In other words, it’s futile to raise British interest rates when factors abroad have boosted inflation here.
So will we see some of these radical changes at the Bank of England when Mr Carney heads across the Atlantic next summer? Perhaps, but they are not without controversy. First, they muddy the roles between what a central bank should be doing (creating stability) and boosting the economy – the job of politicians. Secondly, GDP is a slippery number to target: it’s forever being revised. Finally, inflation may yet return with vengeance and that really would be a beast to fear.