The Politics of Inflation
Martin Wolf has, as ever, a interesting article in today’s FT on the failure of inflation targeting and the need for central bankers to do more about asset price bubbles. Worth a read and I broadly agree with his analysis.
The rationale behind the idea of an independent central bank targeting inflation was that, by virtue of not being politically controlled, an independent CB could take ‘uncomfortable’ decisions to control inflation that would have been harder for a government to take. I.e. a independent CB is more likely to raise interest rates (and raise unemployment) to control inflation. As long as the independent CB was seen as credible than the market would realise that it aimed to control inflation and so take this into account when setting prices and wages, in other words it becomes self reinforcing.
Now this notion is open to challenge. I mean, seriously, the argument boils down to democratically elected politicians can’t be trusted to run the economy. I know many who agree with that statement, I personally do not.
Economists, and increasingly politicians, are now debating the future role of the BOE in terms of controlling asset prices. This is to be welcomed, although personally I don’t think the debate is going far enough. The BOE could be a useful part of any future industrial strategy, lending direct to business that we wish to encourage.
The merits, or otherwise, of having an independent central bank targeting inflation can be debated at length but this can all seem a bit academic and distant.
A more immediately relevant debate is what we mean by ‘inflation’. RPI (which includes mortgage interest payments) is currently negative whilst CPI (which does not) is currently still above the government’s target. So, which is correct? How much are prices currently rising?
The answer is: ‘depends upon how much you earn’. PWC did some good research on this issue last summer, actually looking at inflation rates as broken down by what different income groups actually spend their cash on.
The results, for anyone on the left, make for grim reading. The inflation rate faced by the bottom two deciles of earners (the lowest 20%) has been consistently higher than that faced by the highest two deciles. All things being equal this is, a usually unmeasured and forgotten about, increase in inequality.
Whilst inflation was still rising last Summer, the increase was being driven mainly by rising fuel and food costs. As the lowest decline spend more of their income on these items they faced an inflation rate of 5.7%, against a published CPI figure of 4.7% and top earners only 4.6%.
How should the BOE have responded? Hiking interest rates (which thankfully they did not do, although some MPC members voted to) would have been the standard response. And what would this have achieved? Yes inflation would have fallen but at what cost in jobs? And which people’s jobs?
Any debate which treats inflation as one simple number, relevant to all, is likely to miss these vitally important inequalites. And in any debate on the future of central banking they need to be at the fore.