Why inflation matters

Inflation is up to 2.1%. That may not seem a very big deal.

And as we have a symmetric inflation target of 2.0%, 2.1 is about as close to good news as you could imagine.

But in these fragile times for the financial sector, my own inflation preferences are decidedly asymmetric. At the moment, anything above target severely complicates the management of the economy over the next two or three years. Here's why.

In essence, the argument is that dealing with one problem is far harder than dealing with two. Just as doctors find it harder to give a heart by-pass to a patient with renal problems, a central bank finds it harder to deal with an economic slowdown and falling asset prices, while there's inflation lurking around in the system.

But this argument is particularly important at the moment, as most of the indications suggest the economy is at an interesting turning point. The Bank of England needs room for manoeuvre right now.

To understand exactly why, one needs to follow the chain of events that is likely to occur.

After several years of strong consumer spending underpinned by rising house prices and growing consumer debt, house prices will probably stagnate at best and consumers will probably start to retrench. The turning point has been a long time coming, but it seems to have arrived.

These things happen and do not, on their own, constitute a problem. If we buy more cars than we need in 2006, we buy fewer than we need in 2008. If house prices rise too much in 2006, they fall back to where they should be in 2008. Indeed, I would personally argue that one might see the current economic turn as good news rather than bad.

However, falling house prices and declining consumer spending do become a real problem if they leave the economy with too little spending to keep everybody employed. In that situation, the downward momentum can become self-reinforcing. The slowdown leads to job losses, which lead to further house price falls and further
slowdown, and more job losses.

This is where the central banks come to the rescue. They can prevent that downward spiral by cutting interest rates and stimulating spending.

They probably won't stimulate consumer spending as consumers won't borrow and spend more, whatever the level of interest rates, if they feel they have already borrowed enough.

So the role of the central bank in this situation is to stimulate exports by cutting interest rates and allowing the pound to fall to make exports more competitive.

That leaves the economy a perfectly good escape route from its obvious challenges. The central bank can ensure that at a difficult time the economy continues to grow, workers stay in work, consumers improve their finances and save more. All because exports rise.

But here's where inflation can get in the way.

If the pound falls, domestic prices tend to rise, which obviously adds upward pressure on inflation. If inflation is already above target, the central bank can't allow that to happen.

At a time when we need to extricate ourselves from a difficult situation, we may not have any way out. And we get back into the downward spiral of declining demand and rising unemployment.

The pre-existing inflation can end up being the equivalent of the locks holding the fire escape doors shut. In the end most macro-economic management issues come back to inflation. This is because you can convert many macroeconomic problems - like unemployment and falling house prices - into inflation problems if you want to by printing money to stimulate demand.

This means that as a simple rule, most problems are curable in the absence of inflation, and few problems are curable in the presence of it.

There are still grounds for debate on whether inflation is really a problem at all at the moment. Remove energy, and our rate is on target. And one of the economists I rate most highly, Graham Turner, thinks the Fed may be acting far too cautiously in cutting rates, fighting a non-existent battle against price rises. He was an astute observer of the Japanese economy over the 90s and knows a thing or two about asset price deflations in leveraged economies.

I'm personally agnostic. I just don't know whether inflation is back or not. I've written before about how the "China effect" which has kept our inflation low is surely a temporary one (although a very long temporary), and the current inflation news from China is discouraging.

Moreover, I certainly don't believe in excluding the fastest rising prices when assessing underlying inflationary pressure at home. 2.1 is 2.1 in my book.

But we'll see whether underlying inflation is at or above target over the next year, as the economy undoubtedly slows.

However, there is one general lesson to be drawn from recent experience: it is that flexibility around the symmetry of an inflation target might be helpful.

If things go as crazy as they have over the last few years, with asset prices booming and the economy and consumer spending strong, we would probably have done well to have erred on the side of keeping inflation below target. That would have ensured there is almost no risk of it being above target, so that when this crunch moment inevitably arrives we can stop the drama turning into a crisis.

Comments   Post your comment

  • 1.
  • At 01:41 PM on 13 Nov 2007,
  • harry e wrote:

According to Mr Peston's blog he is 'bemused' as to why the Bank of England did not cut rates last time round. Perhaps you could take the time to enlighten your colleague - you are very good at explaining economic concepts in terms which the most simple can understand.

  • 2.
  • At 01:46 PM on 13 Nov 2007,
  • Paul Pearce wrote:

The reason inflation is so much more of a factor than the headline numbers suggest is that the government uses a measure which bears no resemblance to real inflation. I have several friends who have tried the Office for National Statistics calculator. Not one has come in under 5%.

The government reasonably wants to keep wage inflation down but chooses to overlook that in most instances they are looking to have people take a 3/4% real pay cut by accepting a 2 - 2.5% rise. This is unsustainable and will lead to a huge increase in insolvencies. They should revert to using the wider RPI figure to stop misleading the less informed public and accept that people need a 5/6% rise to stand still after the tax take at the moment.

  • 3.
  • At 01:52 PM on 13 Nov 2007,
  • Josh wrote:

But are interest rates really the only way to solve that? I'm no expert, but if all the existing markets are filling up - No one needs to pay phone makers because we all have phones. - Then surely those people should divert the money they would be spending into new markets, fulfilling different needs, such as more environmentally friendly versions of things. That way we don't try to make people products they don't want, and so don't create waste jobs. What do economists call this kind of thinking?

Interesting times as you say Evan.

If you believe the official inflation figures, that is.

The reality is that inflation is nearer 10% - that's money supply growth less GDP (13 - 3 for arguments sake).

Result? Massive asset price inflation.

I'm afraid it's political - HM Govt have been spending (60 economic quarters of growth) but nasty twin deficits. That's a disgrace.

UK plc will be rated "junk" status pretty soon. If you want a picture of what is going to happen here - look across the pond. A house price crash, probable bank failures and a recession.

We need to ween consumers off debt, start saving and investing.

It's Austrian school I'm afraid, but tell me a fiat currency that's never inflated please.

  • 5.
  • At 01:54 PM on 13 Nov 2007,
  • Mohamed wrote:

An interesting report Mr Davis and very clear as always. Well done.

  • 6.
  • At 01:55 PM on 13 Nov 2007,
  • Scamp wrote:

Evan -

1. It's important to remember that if Brown had allowed house price inflation to be included in the RPI count then bank rates would have moved higher faster and killed off the house price boom much earlier.

2. Fuel price inflation has largely been caused by increased taxation. There is huge scope for reducing fuel prices by reducing taxation.

Ergo - higher inflation has been mainly caused by Govt action.

  • 7.
  • At 01:57 PM on 13 Nov 2007,
  • SimonK wrote:

I may be misreading this, but you seem to be begging the question (in the strict philosophical sense of assuming what you're trying to prove). The argument seems to be that inflation is a problem because any attempt by the Bank to stimulate the economy might lead to an increase in inflation, which is already above target. In other words, inflation is a problem because the inflation target is a problem.

Surely, then, the obvious solution is for the Chancellor to move (or remove) the target. Problem solved - the Bank can reduce interest rates, the economy is stimulated, and all is rosy.

Of course, it may be that having a higher inflation target is bad for other reasons - but if so, you've failed to make that case here.

  • 8.
  • At 01:59 PM on 13 Nov 2007,
  • Tim wrote:

What SHOULD happen is that that interest rates stay high in order to control inflation but that the government maintains consumer spending and employment by cutting taxes and increasing public spending. I'd be able to put up with relatively high mortgage payments if my income tax fell. Of course the Government is prevented from cutting taxes and spending because it has to keep government borrowing to a reasonable level. If only they had cut the national debt a few years ago when the economy was doing better and the country could have afforded higher taxes.

Governments seem to have forgotten that interest rates are only one mechanism for controlling the economy.

  • 9.
  • At 02:04 PM on 13 Nov 2007,
  • Andy Peaple wrote:

I think the UK and the rest of the world are in for some serious payback over the next few decades. As you have pointed out in your article, the UK economy has been run on HPI, MEW and Loans for the last 10 years, many thanks to Gordonron Brown and the BOE.

It's very simple really. What goes up must come down.

The core of all of these problems -including inflation is entirely attributable to one thing:

Fractional Reserve Banking.

  • 10.
  • At 02:07 PM on 13 Nov 2007,
  • Tim wrote:

One point, kind of linked with on the buses. If we assume that migrant labour entering the UK has assisted in keeping inflation lowish (not house prices I admit). If there were less jobs in a faltering economy would some of the EU migrants start to look to other parts of the EU? I cannot imagine people flooding in looking for work in an expensive country when there is limited work available and those that have been in the UK might be tempted to take there savings back home where they effectively get more for the pound.

This could impact the wider economy or too small to impact it? What past examples have there been of this state of affairs we might draw saome guidance from?

  • 11.
  • At 02:08 PM on 13 Nov 2007,
  • William Gingell wrote:

"He was an astute observer of the Japanese economy over the 90s and knows a thing or two about asset price deflations in leveraged economies."

What does leveraged economies mean and what other types of economies are there?

  • 12.
  • At 02:11 PM on 13 Nov 2007,
  • Geaton9000 wrote:

Quite a few problems brewing as far as I can see. Firstly anyone who actually believes that inflation is really 2.1% must be living in a cave wearing animal skins (how about doing a piece on how the measure of inflation has changed over the years, which has had the effect of producing an acceptably low figure)- costs for just about everything are rising fast. Secondly, how come when our economy has been "doing so well" has there been so much reliance on debt and borrowing to make ends meet and thirdly, that most peoples source of wealth i.e. equity withdrawl, has come to an abrupt end. House prices are falling and people will still owe every penny of what they have borrowed against their property. It amazes me that the Wall St crowd are so surprised by any of this. Suggest one reads The Daily Reckoning - messers Bonner and Wiggin have been predicting this for close on two years now.

  • 13.
  • At 02:14 PM on 13 Nov 2007,
  • Peter Arnold wrote:

Inflation as measured by CPI - which excludes the costs of housing may be only 2.1%, but RPI, which includes housing costs has risen to 4.2%. The old target for RPI was 2.5%. On this basis it is clear that the economy is overheating. We shouldn't expect interest rates to come down anytime soon.

  • 14.
  • At 02:16 PM on 13 Nov 2007,
  • Michael wrote:

I agree with the difficulties faced, but strongly disagree with the assumption that lowering the rates will not result in many people out there increasing their borrowings even further, and further increasing the bubble, which will ultimately solve nothing.

  • 15.
  • At 02:39 PM on 13 Nov 2007,
  • Simon wrote:

Gordon Brown has caused huge inflation over recent years with his tax, over regulate and squander policies. The bloated beaurocracy he his built up is unsustainable. He has hidden this inflation behind a huge Pound. The 10 years of an overvalued currency has exported millions of jobs. Job losses he has hidden, long term sick, gay rights team leaders, etc.

He has precided over Enron accounting, that is debt as earnings.
Economic growth has been Public sector only.

We now cannot export our way out of this slow down as we have already exported our exporters. Even Rolls Royce have opened their new sites abroad. If the Pound comes down Gordon's inflation will become obvious to all. He will therefore try to keep the Pound as high as possible for as long as possible.
Each day destroying more of the true economy.

Now that the UK property bubble has burst, eventually the Pound will come down and with no British suppliers left we will all be at the mercy of foriegners and a weak currency. That means huge stagflation.

Please can we go back in time ten years with a policy of a correctly valued currency. Cutting Government spending and stimulating the private sector.

  • 16.
  • At 02:40 PM on 13 Nov 2007,
  • Yummy Carol Kirkwood wrote:

Inflation will be a much bigger problem over the coming decades than pretty much all mainstream commentators currently give credence. We have been fortunate enough to benefit from a very benign inflationary environment for 20 years, and the expectation is that we will continue to do so for the next 20 - an example of "Recent Event Syndrome"...

Evan, what are the economic reasons for the chancellor's decision to switch to CPI from RPI? I know the political ones - it looks better, smaller numbers, easier to control, etc - but is there a good economic reason why RPI should be ignored as a statistic?

The ONS website is proving particularly intractable in obtaining RPI figures, so I obtained figures for 2007 from another site:

Inflation is running far higher than Dear Leader would like us to believe.

  • 18.
  • At 02:44 PM on 13 Nov 2007,
  • Tom wrote:

Price targeting is falling under question from all sides. We cannot accurately measure prices, which is why CPI is not representative of the inflation that the general public are experiencing. It is hard to determine what constitutes typical spending habits (should we be measuring the spending of comfortable people, or those struggling to afford enough food), and how to adjust for changes in quality of products (if a kettle now lasts 2 years instead of 10 and is half the price, is that inflation or deflation?).

Plus there is this absurd notion that you can fix the current problems with rate cuts, when keeping rates too low for too long was what led to the problem in the first place! Add to that the fact that the central banks can only control overnight rates and the long term rates that most borrowing is based on are not responding to the central banks adjustments, and you have a hell of a mess, which is where we now find ourselves.

  • 19.
  • At 02:47 PM on 13 Nov 2007,
  • ashley wrote:

could you not start sentences with 'and'
,it is very poor style.

thank you

  • 20.
  • At 02:47 PM on 13 Nov 2007,
  • ale bro wrote:

RPI is at 4.2%.

Not long ago RPI @ 2.5% was seen as a sensible target for inflation.

Inflation is showing up in the RPI statistics more than CPI.

When CPI was introduced, the justification for a move to a 2% target was that CPI would be below RPI by 0.50%. The gap between the two indices is now 1.7%.

The high level of RPI means that inflationary risks are more present than the level of CPI @ 2.1% implies.

  • 21.
  • At 02:47 PM on 13 Nov 2007,
  • Bernard I. Turnoy wrote:

Indeed, falling asset values and a simultaneous rise in inflation are a combination that calls for a corresponding downturn in an economy on the macro-basis. Add exponential rises in energy prices, defaults on mortgage backed securities - on an unprecidented scale, a trade balance deficit and a national / federal deficit, and it's a receipe for economic disaster. The American failure to adequately oversee mortgage backed securities, coupled with deficit spending - at least at the federal level, often as well on the state, county and/or local municipal levels, while adding in offshoring of formerly domestic jobs and you've got a free-falling US Dollar. The Federal Reserve has now been locked into a 'damned if you do and damned if you don't' monetary policy. If they lower rates further in an attempt to stimulate the economy they will - no doubt, exacerbate inflation and push the Dollar down further. If they {the Fed} raise rates to hold down inflation they're going to raise the cost of funding the deficits and debt-service, add to the existing 'credit runch' and curtail domestic spending/growth at a time when spending and growth are in contraction. What this all adds up to is that the American Economy is in decline. Just how speedy the decline is depends on some external variables beyond Wall Street and/or the Fed's ability to manage. Any further disruptions in the flow of oil from the Middle-east, or other...strategic global events would suffice to send the American economy into a late 1920's-1930's mode. At best, the American economy is in for an extended period of 'stag-flation.' Should China begin to significantly unload their US Dollar surplus is but one of the countless landmines in place to further disrupt the US economy. One thing's for certain, the true costs of deficit spending on wars of dubious basis, of trade policies that give away both developed technologies and jobs, as well the grotesque underfunding of Social Security [the federal pension scheme] and Medicare [the federal medical assurance program for seniors], as the 'baby-boom' generation gets set to retire are going to put further downward pressures on US securities. As the 'boomers' set to retire and liquidate their holdings to retire / live on, with housing values depreciated and costs of living rising on all fronts, there can be little doubt that the 'value' of the Dollar has only begun its slide, and that Wall Street's valuations are in for a profound correction. There really is no good news on any of these fronts for the American economy and - for an economy that's driven mostly by consumer spending, when that spending [inevitably] dries up, there's only one direction that can possibly follow. Obviously, the course that's been set is southward and onto the rocks. Abandon ship is the inevitable call and the American 'brain'drain' of the new century has only just begun.

  • 22.
  • At 02:53 PM on 13 Nov 2007,
  • Richard Hadden wrote:

Most problems can be converted into inflation. This article misses the point slightly. It is not the presence of inflationary pressure that will of itself prevent a solution; it is actually inflationary pressure that offers one solution to the impending debt crisis. One way to reduce the real burden of debt is to inflate it away.

The question is whether the BoE, Fed etc. have any *other* solutions to the "credit crisis", that do not rely on reversing the past 20 years' gains in delivering stable low inflation....

  • 23.
  • At 03:02 PM on 13 Nov 2007,
  • Matt wrote:

Small point, but by the ONS usual definition CPI inflation is actually 2.0% not 2.1%. They have made a mess of their calculation.

The October 2006 index figure is 103.2
The October 2007 index figure is 105.3

The difference is 2.1 but the percentage change is 2.1 divided by 103.2 which equals 2.03%. They normally round to the nearest single decimal place which should be 2.0%, not 2.1%.

Bearing in mind the current sensitivity in the markets to inflation and interest rates I think they should issue a correction.

  • 24.
  • At 03:05 PM on 13 Nov 2007,
  • Matt wrote:

Russel Long, there are plenty of figures on the ONS web site for past inflation.

Full CPI release here:

Link to various time series going back as far as 1947 here:

Select consumer price indexes from the box and there is a good selection of raw numbers there to work on.

  • 25.
  • At 03:06 PM on 13 Nov 2007,
  • Brian Anderson wrote:

It is my understanding that the government froze public sector at 2% to keep inflation down but has then increased inflation by putting up fuel duty. Surely this is madness.

  • 26.
  • At 03:12 PM on 13 Nov 2007,
  • Chris wrote:

Hi Evan

Excellent, balanced article! I too am agnostic on the prospects for inflation and how it may affect the UK economy. Whilst it is clear that inflationary pressures at the moment are on the up (though rising food and fuel prices), my own view is that the Bank of England has some breathing room at the moment to manage this. After all, CPI inflation is at 2.1% (well within target) and the economy is currently growing robustly at 3.3% pa though customer and business surveys are now beginning to suggest that confidence is beginning to wane, indicating that economic growth may be about to slow down. In the current circumstances, that's not necessarily a bad thing.

If the upward inflationary trend persists, then it's my view that the Bank of England can afford to keep interest rates at their current high rate. True, the economy will now start to slow but, if the Bank can also maintain the squeeze on wages, then the combined action of a slowing economy and wage-price squeeze should see off the current inflationary threat without sending the economy into recession. Then, when the current inflationary spike is over, the Bank will be in a position to start reducing interest rates to allow the economy to grow more robustly again.

I appreciate that the global economy is entering choppy waters at the moment, thanks largely to the fall-out from the sub-prime mortgage crisis in the US. However, at the moment, I don't share the doomsday scenario for the UK economy because with low-ish inflation, strong economic growth and high employment we're currently well-placed to see off the troubled times ahead.



  • 27.
  • At 03:16 PM on 13 Nov 2007,
  • James Daly wrote:

There seems to be an element of confidence here based around a dependance on the validity of the calculated rate of inflation - I suspect both are in doubt. I don't know how inflation is currently calculated but my personal take on how the cost of living is rising is that it has continued to rise quite sharply for some time; especially in terms of the cost of essential or mandatory items (food / energy / taxes etc.) But of course there is so much I don't understand these days - in fact nothing really seems to make sense - I can get any range of opinions from the media but, I suspect, very few facts. Logic tells me that far from being in a position of strength we are in a rather dire situation where far too much dependance has been place on the 'ability' of the financial sector and far too little on generation of new wealth; ie wealth that is not generated by steeling from the masses through systems, designed by the financial sector, to encourage indebtedness (and boost their bonuses). The bottom line is that the economy is actually weak, the outlook for the future frightening and we are being led by the blind.

  • 28.
  • At 03:18 PM on 13 Nov 2007,
  • Yummy Carol Kirkwood wrote:

Just a slight addendum to my previous comment.

When I said "We have been fortunate enough to benefit from a very benign inflationary environment for 20 years" I should also have remarked that we probably avoided a period of DEFLATION (following the bursting of the bubbles at the turn of the millennium) only thanks to historically low interest rates.

BTW, the "60 quarters of continuous economic growth" (or whatever), do those growth figures take inflation into account? Were some of those quarters of growth actually quarters of contraction in real terms?

  • 29.
  • At 03:25 PM on 13 Nov 2007,
  • Alexander Davidson wrote:

When the rich stick their capital into Gold, commodities, Yuan or Swiss Francs, as they are doing now, the inflate-away debts' tricks played by governments fail.

Broon wants King out so he can play the inflation card. However, unlike the 1970s, the foreign investors won't be conned and will immediately pull their capital out.

So, unemployment will rise, immigration will reverse, house prices will crash and 'incapability' Broon/NuLaber will be out on their ears in 2009! Good riddance!

  • 30.
  • At 03:25 PM on 13 Nov 2007,
  • smithers61 wrote:

Inclined to agree with SimonK that it would be useful to discuss whether the inflation target is more important than the health of the economy. To go back to your own medical analogy - just because a patient has slightly high blood pressure - you wouldnt necessarily refuse to prescribe crucial drugs that made the b.p. slightly worse. Having watched the Irish economy indulge in high levels of inflation (that had the uk scribblers predicting all sorts of trouble) I'm still waiting for the chickens to come home to roost. The bank's inflation orthodoxy needs challenged - but the bbc seems incapable/unwilling of even acknowledging that there could be a debate to be had about it.

  • 31.
  • At 04:02 PM on 13 Nov 2007,
  • Dee Gee wrote:

I agree with post 3.
Inflation is nearer 10% - ask any pensioner about the increase in milk, bread and eggs, petrol, train fares and council-tax.
The pound is high, when it drops inflation will really rise and the government will be able to con us no longer.
I don't have any answers, but feel I am in good company as no one else, let alone the government seem to have any either.

  • 32.
  • At 04:08 PM on 13 Nov 2007,
  • peter wrote:

A point about the sub-prime problem in the US which I haven't seen spelt out:
My cousin is a mortgage broker in the US(one of the people who created this mess...) - he makes his money by arranging a mortgage (collecting, say, $5k commission) but then spending part of this commission on paying the penalty to extricate his client from the mortgage before it moves from the introductory 9% to the boosted 14% (for example) interest rate. He then re-finances them every 6-12 months and has a stream of income from each client (and only needs a small stable of clients, rather than new ones), where he uses part of his commission to pay their early-exit penalties and also as sweeteners to keep them loyal... What I'm saying is that these people will now find it impossible, due to the credit crunch, to re-finance and to stay on introductory interest rates. People who could have avoided defaulting on their sub-prime mortgages will now not be able to afford the boosted interest rate and the number of defaults will spiral upwards exponentially.

I haven't seen this spelled out anywhere so far: Some defaults in sub-prime US mortgages have led to a credit crunch. But the credit crunch itself will then lead to a massive acceleration of defaults due to the inability of people to re-finance back onto introductory interest rates.
Mortgage brokers in the US have actually been making their money not simply by selling lots of dodgy mortgages and lying about incomes etc. (although there has no doubt been a lot of that too) but through continual re-financing (playing by the rules of the 'game' without anticipating that the rules would change).

It also follows that the actual risk to the UK depends in part upon the extent to which people here continually re-finance onto lower interest rates - and therefore the proportion of people vulnerable to defaulting if expected to pay the interest rates they signed up for (if unable to re-finance).

  • 33.
  • At 04:14 PM on 13 Nov 2007,
  • Tim Young wrote:

I would dispute the conventional thinking that the mistake that Japan made was in not easing fast enough. The easing in both monetary and fiscal policy that was done held up asset prices, discouraging potential buyers by making prices a one-way bet downwards, while essentially bankrupt companies were able to remain in existence and taking business from viable firms. Even after having eased to the point of a huge stock of government debt and near-zero interest rates, the Japanese economy remains sluggish. Ironically, one reason for continued pessimism seems to be the size of government debt and consequent expectations of tax increases. If we assume a reasonable potential growth rate for Japan’s economy and cumulate the lost output since the bubble burst, it probably would have been better to let asset prices fall hard, if necessary at the cost of a deep recession, waiting until assets become cheap before easing aggressively with plenty of ammunition still left.

For this reason, I hope that the Bank of England will hold the line on inflation as the going gets tough, and that Mervyn King, who seems to be the man for the job, will be reappointed as BoE governor.

  • 34.
  • At 04:26 PM on 13 Nov 2007,
  • Richard Marriott wrote:

Agree totally with your excellent article where inflation is concerned. However, there is another elephant in the room - public spending. If the economy goes into decline and the Bank cannot cut rates, you should be able to rely on some pump priming from the Government via fiscal measures. Unfortunately though, "prudent" Mr Brown already spent all the money in the Government spending kitty when it was least needed and there is no spare cash for pump priming when it is needed. Now will PM Brown carry the can for mistakes made by Chancellor Brown?

  • 35.
  • At 04:28 PM on 13 Nov 2007,
  • Jonathan Griffith wrote:

Are interest rates the only way of managing an economy? Remember the Thatcher years? What about fiscal policy!

But there again my economics degree is 30 years old!

  • 36.
  • At 04:29 PM on 13 Nov 2007,
  • alan wrote:

At 02:47 PM on 13 Nov 2007,

ashley wrote:
could you not start sentences with 'and'
,it is very poor style.
thank you

Please start yours with an upper case letter, and include a space after a comma, as that is even worse style

  • 37.
  • At 04:37 PM on 13 Nov 2007,
  • MIKE WEAVING wrote:

An excellent article, which clearly points the finger. Food and transport. Not much we can do about food, particularly after the UK weather earlier this year.

Transport costs are another matter. Oil price up. That's the worldeconomy, but as prices rise, so does the tax take. Mr Brown, why not give up the tax windfall on oil price rises. Cuts the price, lowers inflation and gives the Bank of England leeway.

What's that I hear? Oh yes, tax and spend.........

  • 38.
  • At 04:49 PM on 13 Nov 2007,
  • rob mcmahon wrote:

I spotted a (deliberate) mistake- 1st line, 3rd paragraph. Surely 2 probs simultaneously are HARDER than 1?

  • 39.
  • At 04:50 PM on 13 Nov 2007,
  • IanS wrote:

This is madness. The Bank of England have one real way of controlling inflation, interest rates, but what use are they to an inflation figure being driven up by rising fuel costs? Costs which are rising through no fault of the Bank of England. They could put interest rates up to 15% and it wouldn't make a bit of difference to inflation. The cost of fuel is in the sole control of one Mr. Darling. IF he reduced the duty on fuel by 2% that would be enough to reduce inflation as it would make goods and services cheaper. Surely this is a better way of donig things than making loads of people homeless??

  • 40.
  • At 04:51 PM on 13 Nov 2007,
  • chris wrote:

How about the government forsaking a % of the tax they screw out of every driver at the pumps? Would this not then reverse the increase??


I enjoyed the article, but regardless of where inflation actaully is at the moment, and it is certainly above 2.1%, it is probably low compared to future inflation. The pound can only fall against the dollar in the long term and with almost all of our high streets chains buying in dollars:- well, you can see where I'm going.



  • 42.
  • At 05:55 PM on 13 Nov 2007,
  • Leonardo wrote:

First, I disagree with your diagnostics of the economic outlook. The world economy is booming, and rising food, oil and house prices are just one of the several signs of this. Through this point of view, interest rates should be, for the time being, either kept on hold or raised. This whole credit cruch thing is exactly a symptom of too low interest rates being around for far too long!

  • 43.
  • At 05:56 PM on 13 Nov 2007,
  • Andrew Lilico wrote:

How much higher do you think inflation could go before the MPC would have to start considering, again, a rise to 6%? The August inflation report suggested that 5.75% would not be enough to get back to target on a two-year-ahead horizon. There were also a number of predictions that rising prices for food and other minor items would take CPI well above 2% in late 2007/early 2008. Since then oil prices have risen considerably further.

We have, of course, also had the credit squeeze and the Northern Rock affair. Most commentators seem to operate on the assumption that these mean that the possibility of further rate rises can be totally discounted. That seems to me to imply one of three things: (a) The previous argument that more rate rises would be necessary was wrong; (b) The credit squeeze has changed something permanently such that inflation expectations should now be lower; (c) The credit squeeze, thought temporary in effect, has meant a delay in rate rises that means the window of opportunity passes before aggregate demand cooling obviates the need for rate rises and necessitates cuts, instead.

I reject (a). It's a bit early to be predicting (c) with any confidence, IMO. So that leaves (b) - something has changed. But what? What, precisely, has the credit squeeze changed, permanently, that now means inflation expectations should be lower over the next two years?

  • 44.
  • At 05:57 PM on 13 Nov 2007,
  • Phil wrote:

Not a terribly enlightening article, but there are some interesting comments.

Evan, everybody else is waking up to the fact that the CPI figure is a nonsensical irrelevance, so why are you taking it so seriously?

As others have pointed out, real inflation is racing away, and the end of cheap credit is in sight. Really there is very little the BoE can do. For a long time its interest rates have had very little influence on the price of credit, which has been set on the world stage. The monthly farrago has just been part of Gordon Brown's smoke and mirrors act. Why do you think he was even contemplating an election?

  • 45.
  • At 05:59 PM on 13 Nov 2007,
  • Jon wrote:

The CPI rate bears no relation whatsoever to the rate of inflation experienced by ordinary British citizens. Why does the BBC constantly quote the politician's figure when the RPI rate is far more relevant to readers and viewers?

At least give the RPI rate equal billing, because CPI is an irrelevance to most of us.

  • 46.
  • At 06:17 PM on 13 Nov 2007,
  • douglas sloan wrote:

Is this not a case that we are entering the classic Stagflation part of the economic cycle where inflation keeps rising as markets start dropping

The only trouble is that because Government hide true RPI inflation, which includes mortgage costs, people in the street do not get told about it until it is well and truely established or until a sudden market fall announces it's arrival.

Overall the US and the UK are relying on consumer spending (the CPI Index) wich does nothing for our understanding of real inflation or to UK Plc Ltd real economic growth. In fact it encourages huge deficits which eventually have to be paid for in job losses and deflation if not recession.

We are also now in a Global economy where China, India, South America and possibly Russia will not allow the West to dictate/manipulate global finances and deficits as they once did by spending our way out of trouble using the very considerable buying power of the US.

The present drop in value of the $dollar and the rise in oil price to compensate and retain the true value of a barrel of oil is a better indicator of what is happening.

Trouble is we have to pay for it from disposable income that has been substantially eroded over the last 10 years by Mr Brown and the Treasury.

It also means there is a very good chance we will continue to see high inflation followed by a continuing drop in the US/UK/EU stock markets until the economic cycle re-stabilises at a lower level. i.e. you and I have to become substatially poorer to balance the global books

I believe we are in for a period of Stagflation and do not have the means to climb out of it as we once did.

D. Sloan

  • 47.
  • At 06:25 PM on 13 Nov 2007,
  • jonah wrote:

And more babble quoting the official interest rate, which means nothing to anyone except statisticians and the government.

Does anyone actually see such modest increases in their cost of living? It's all very well weighting cheap DVD players from China, but when the "merde" (to borrow the word from your colleague Mr Peston) hits the fan we can live without DVD players and widescreen TVs. We can't live without food and energy, which seem to be rising much faster than any 2.1%

Unfortunately when the Bank of England bases its decisions on a flawed statistic the result is unlikely to be a happy ending. To coin the computing phrase, "garbage in, garbage out".

  • 48.
  • At 06:40 PM on 13 Nov 2007,
  • TRUST_NO_1 wrote:

Inflation 2.1%
Is that per week,because it sure ain't per annum ?
Even Evan knows he is talking hot air when he quotes this propoganda.

The government will soon surely increase the house price element of 'inflation'..because house prices are going down,down,and further down very soon.

  • 49.
  • At 06:59 PM on 13 Nov 2007,
  • Joe wrote:

I think we're entering a kind of downturn which hasn't been encountered before. One thing that may be different about the downturn is that the 'professionals' will be the first to feel the pinch. Falling house sales will see solicitors/estate agents cutting back, this will force the BMW garages etc. to cut back. The amount paid to accountants for IVAs has already been slashed. These and other professions tend to be the people who have borrowed more for their houses.
Billions lost from stamp duty due to falling house sales will see larger increases in council tax etc. This government has tread water for far too long.
I'm a bit of a newcomer to economics but find all this fascinating, especially when I see people predicting interest rate cuts. There's no chance of that in my mind. Sadly it's a fact of life that you can't have too much of a good thing (if paying over the odds for a house is deemed a good thing). I think the economy is stalling around the top of the funnel, ready to go down the plughole.

  • 50.
  • At 07:17 PM on 13 Nov 2007,
  • Iain wrote:

Hi Evan,

Could you help explain where all the money has "gone"?

An article I read somewhere else on this site suggested that trillions may be lost. But to where I wonder?

If the banks previously made profits those went either to staff (in bonus payments) or to shareholders or were reinvested in goods and services. The recipients of this money have spent it on things i.e. houses in the same way that people who have sought to release equity from their properties have spent money in the DIY store or on a 2-week holiday in the US.

The money keeps on circling doesn't it? Or is there a drain that it trickles/floods down and is gone forever?


  • 51.
  • At 07:50 PM on 13 Nov 2007,
  • malcolm wrote:

Since taxation increases are responsible in part for the inflation increase why not cut tax and bring inflation under control.

  • 52.
  • At 08:37 PM on 13 Nov 2007,
  • Chris Harrison wrote:

We wouldn't have had so many problems on the horizon if RPI had remained the BOE target for monetary policy. If this had've been the case house prices would not have gone as out of control as they have done, living costs are rising at rediculous rates because by concentrating on CPI we are no longer reflecting the true cost of living increases.

The bigger the boom, the harder the fall in my opinion, this governments irresponsibility with inflation measures may appear to the layman that economic success, but it is based on false hope. So called stability could be shown up in the end as poor management by Brown.

  • 53.
  • At 10:37 PM on 13 Nov 2007,
  • Lee Moore wrote:

In fact, since Gordon Brown became Chancellor, CPI inflation has been little more than half RPI inflation, so the notion that there's just a 0.5% difference is ludicrous. This shows clearly that Gramsci had it right - control of the language is the essential route to political control. The fact that the BBC's economics editor can begin an article with "Inflation is up to 2.1%" when in reality it is over 4%, and never mentions in his whole piece that he is referring to a transparently bogus inflation measure that ignores the biggest item in household budgets - housing - shows how totally Gordon Brown has managed to control the language of debate about economics. Why the media has let him get away with it is another story, but however he has achieved it, we surely have to applaud his command of spin, even as we laugh at the idea that his premiership will usher in a new age of openness.

  • 54.
  • At 12:59 AM on 14 Nov 2007,
  • Mark wrote:

I hope British government economists see it they way you do. It's comforting to know that your competitors are clueless. The difference between 2.0% and 2.1% is 5%, far less than the interval of confidence of the measurement itself. Furthermore, inflation is a very complex concept, a single number cannot begin to express its meaning. And it is only one factor in judging the performance of an economy. Also, revisions made at a later date often change the numbers looking at them in retrospect by more than 5%. Keep using your microscope instead of your telescope and keep telling yourself its the little picture that counts.

  • 55.
  • At 09:49 AM on 14 Nov 2007,
  • Mike Wilson wrote:

When are people going to wake up to the fact that you cannot run an economy on ever-increasing levels of debt forever? Even the government talk about a 'cycle'. You can borrow for a while but you can't borrow ad infinitum. If you do, sooner or later, you will have a credit crunch. Oops! We've got one!

So, what's the answer when finally, as it must, an economy built on debt begins to slow as people either reach the limits of what they can borrow or credit dries up? LOWER INTEREST RATES SO THE PEOPLE CAN BORROW SOME MORE. The people in this country collectively owe 1.34 trillion on credit cards, mortgages and personal loans. That, apparently, IS NOT ENOUGH! They must borrow more to keep the economy growing. It is MADNESS and will end up in a slump (not a recession) if it contines. When are people going to start talking about saving and investing instead of borrowing and spending.

  • 56.
  • At 09:53 AM on 14 Nov 2007,
  • Richard wrote:

Isn't higher inflation a good way to reduce the real level of debt?

  • 57.
  • At 10:59 AM on 14 Nov 2007,
  • Alex wrote:


The USA chancellor kept interest rates too low for too long a period.

The UK chancellor set the wrong criteria for measuring inflation, so interest rates were kept too low for too long a period.

Money supply is growing in double digit figures in many countries, so inflation is bound to rise.
I'm a mechanical fitter to trade, so no economics background, but hey, more money chasing same amount of goods means people will pay more for the goods.

Now there is a proposal to put Alan Greenspan in charge of a revised IMF - it would be nice but gullible to believe that because he caused the asset inflation bubble that he could fix it.

...must go for a haircut, which has gone up in price by 100% in 5 years, for less hair to cut.
But has the barber really put up prices if they are getting more for less - as measured using the CPI criteria.

  • 58.
  • At 11:49 AM on 14 Nov 2007,
  • John Breckon wrote:

Evan Davies writes
"there are still grounds for debate on whether inflation is really a problem at all at the moment. Remove energy, and our rate is on target"

This is nonsense - you cant keep removing things from the inflation calculator just because it suits or we could just remove everything and then inflation would be officially zero.

Most people know that inflation is going up faster than the RPI never mind the goverenments CPI fiddled inflation measure which their puppets the BBC now call the inflation rate.

  • 59.
  • At 12:42 PM on 14 Nov 2007,
  • DaveH wrote:

Proof - if any were required - that the BoE is not independent comes in today's inflation report, where the Bank says it can keep to its "2% target" next year even if rates are reduced by 0.5%. Having ramped up consumption and debt, the Bank is now being leaned upon to reduce the cost of government borrowing and to add more petrol to the consumer debt fire ina desparte attempt to "maintain consumer confidence" by keping the housing bubble going. Erm, I think this tried this a couple of years ago by reducing the rate to 3.5% (0.5% below the liquidity trap where rate changes only ramp asset prices) and look where we are now. The Bank should have kept rates consistently higher and we would not be in the mess we are in now.

If rates are cut, the UK Pound will fall and up will go input prices and values of cheap Far East imports, so adding to inflation, but at least that will lag 18 months behind loose financial policy and give GB the chance to go for an election in still apparently healthy times.

  • 60.
  • At 12:49 PM on 14 Nov 2007,
  • Todcod wrote:

'you can convert many macroeconomic problems - like unemployment and falling house prices - into inflation problems if you want to by printing money to stimulate demand.'

Long live the Phillips Curve!

  • 61.
  • At 08:56 PM on 17 Nov 2007,
  • Simon Stephenson wrote:

I'm afraid that I am rather sceptical about the claims of how robust the economy is, as demonstrated by 15+ years of uninterrupted economic growth.

I'm trying to combine my 35 year old economics training with my 30 year old accountancy training to explain what I consider is an anomoly.

I'm looking at GDP, the growth of which year-on-year is the most used measure of economic growth. Ignoring inflation for a minute, my accountancy tells me that annual GDP can be calculated by taking the difference between closing national wealth and opening national wealth,
and adding this to annual consumption. This seems right to me - as more of an accountant than an economist.

So, when Germany stimulated its economy in the 1930s by rearmament and public works such as autobahn construction, the GDP that this created would be measured by considering the cost of the armaments and autobahns to be value added to national wealth. Is this correct? I think so, but here comes the anomoly. Wouldn't GDP as stated have been exactly the same if, instead of making arms and building autobahns, Germans had just been paid for digging holes and filling them in again? The point being that if national statistics determines value solely on the basis of cost, aren't we in danger of fooling ourselves that everything is hunky-dory, when in fact a proper valuation of closing national wealth is miles below the stated figure, meaning that we haven't really been experiencing the continued annual growth of GDP that the Government keeps crowing about?

Wouldn't a proper audit of the validity of the closing national wealth figure be reassuring to those, like me, who suspect that this is treated just as an unchecked balancing figure?

  • 62.
  • At 12:44 PM on 21 Nov 2007,
  • Mark Knowles wrote:

Like all economic arguments there are long processes to be followed on both sides. It is too difficult with the amount of factors involved to clearly state a cause and effect accurately. Economics is a social science after all and deals with a "rational" person.

My way of thinking today would lead me to agree with earlier comments that monetary policy is not the only way of controlling the economy/inflation.

Inflation being an indicator of rising prices shows demand is constantly higher than supply.

With regards to
the obvious rise in Asset prices, namely houses, it is clear that homeowners have been using future house prices as a means to decide their purchasing power. If people were to be taxed as per capital gains tax on the difference in house values (as in other EU countries) they would deterred from relying on these assets as future income. I understand developers have to pay taxes (if they don't live in the home etc) but normal homeowners do not - instead purchasers pay stamp duty (unfairly on an inflated house price).

The runaway housing market has outweighed the relative cost of unsecured debt which has been too cheap and hence people have had it too easy. These two factors have been ignored because this feel-good factor of being able to buy what you want has been left unchecked by not having correct financial implications. Indeed mortgages are only given out with the house value being the collateral so the banks are equally to blame for this dream of a never-ending rise.

I know that local housing markets depend on supply and demand traditionally but it is clear that prices are inflated by probably 20-30%. However people are only forced to sell their homes if they don't have enough room (children), they relocate for work, or if the can't afford the monthly payments.

If this causes a glut then of course house prices will fall which should stop people selling until only the financially crippled are forced to sell/become repossessed by the banks/building societies.

With regards to Banks and Oil companies, their coiffers are full of reserve cash from huge profits made over the last 10 years and they should be able to ride out the storm by making people redundant should a fall in demand occur.

On the supply side it's clear that crop shortage, fuel shortage etc = higher prices and technical goods will rise in price if wage demands or raw material costs increase in places such as China. All of which is out of anyone's control (in the UK).

This is important because the more we buy imported goods (especially with an over-valued pound) and the more we rely on the service industry and luxury goods market for employment we will struggle to control our own future when the economy leads to people only making ends meet to buy basic commodities then we will find a lot of people unemployed with no means of re-employing them without government intervention (subsidies), which it will struggle to afford without borrowing more...

  • 63.
  • At 05:16 PM on 22 Nov 2007,
  • Simon Stephenson wrote:

House Prices

What's the real value of a house, and what are the factors that make this different from actual price levels?

Land - the granting of planning permission immediately multiplies by at least 150-fold the cost of land, from a non-developable amount of perhaps £3k/acre. Why? All that has happened is that the landowner has been granted a right by the planning authority, and this turns him overnight from being perhaps a moderately prosperous farmer into a multi-millionaire.

What on earth is the social purpose of this? Is it not possible to accept the desirability of proper Town and Country planning without creating, as a direct result of the planning process, a completely ridiculous market in development land?

If non-developable value is a reasonable, market-driven price for land, as such, then the cost of the land becomes a relatively small part of the total cost of house construction. What new home-buyers are also paying is a vast sum that filters back to the original landowner, and that is created solely from a planning committee's decision to grant development permission for that particular piece of land.

Other than for the landowners, can anyone come up with an argument why this is a sensible way of doing things?

I'd hazard a guess that the breakdown of the make-up of a new £250k house on an estate is something along the lines of:-

£300 Land - real cost
£60,000 Land - development permission
£50,000 Construction cost, including estate utilities
£139,700 Profits, taxes, commissions to middlemen and agents

I'd be interested to hear if I'm far wrong.

  • 64.
  • At 09:57 AM on 20 Dec 2007,
  • Tyro wrote:

You're all experts on this.

But I know that CPI is not RPI.

I pay council tax. I pay for petrol. I pay fuel bills.

I also suspect that the easiest way for the government to get out of this is through inflation.

Governments always take the easy way out. The headline figures look good.

House prices now are built on the inflation of the 70's and 80's. Mortgagees are now keeping their fingers crossed that in the 2010's and 2020's house price rises will take care of their pensions.

Who in the government (or in the banks?) is looking after the money I have right now?

  • 65.
  • At 04:17 PM on 28 Dec 2007,
  • john wrote:

Stable or slightly falling house prices, inflation about 2%, record levels of employment, the pound falling to more sensible levels, public sector pay rises finally coming under control, public finances broadly in balance.

So what is the problem? Even the subprime crisis is starting to calm down despite the best attempts of the press to sell more papers by sensationalising it and making people panic.

All that needs to be done is two more consecutive rate falls by 0.25% to 5% to stabilise things. That should get rid of liquidity problems and allow exporters to pick up the slack. The overvalued pound has been this countries biggest burden for ten years and it is about time it fell. Do not believe this nonsense about runaway inflation, it is a red herring espoused by those who want a house price crash. What we really need is a degree of stability.

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