Duncan’s Economic Blog

Inflation, Growth & Household Savings

Posted in Uncategorized by duncanseconomicblog on May 17, 2011

This morning,  as CPI inflation rose to 4.5%, Ben Broadbent, the newest member of the Bank’s Monetary Policy Committee, appeared before the Treasury Select Committee.

As expected the former Goldman Sach’s economist took a relatively dovish position on interest rates and inflation and early indications are that he will be closer to arch-Dove Adam Posen than the hawkish Andrew Sentence he has replaced.

Labour’s Angela Eagle said this morning that:

“The Bank of England has been put in an impossible position by George Osborne. It has been left to do all the work to support a recovery that’s been choked off by the Tory-led Government’s fiscal policy to cut deeper and faster than any other major economy in the world.”

This is a view I certainly share – George Osborne’s hopes for ‘expansionary fiscal contraction’ rely on the Bank providing monetary stimulus to offset the impact of spending cuts – but given high inflation, it is getting harder and harder for the Bank to give this support.

As Eagle noted January’s VAT rise has added to inflation, making the Bank’s job all the more difficult. This morning’s figures revealed that with constant indirect tax rates (VAT, duties, etc)CPI inflation would have 3.0% rather than the current 4.5%. In other words tax and duty changes are adding substantially to inflation – explaining, for example, the record monthly jump in alcohol & tobacco prices in April.

Broadbent appeared to agree with much of this line of argument, noting that the fiscal retrenchment ‘may be one of the reasons why growth has slowed’ over the past months but also saying that ‘there’s no room for a rate reduction’.

In other words, fiscal policy is slowing growth but the Bank’s options are limited by inflation. Broadbent also rejected a comparison of the Uk to Portugal, Greece or Spain and whilst he argued that fiscal tightening was necessary he did say that the exact policy package could be altered if the macro-outlook changes. There is, for Broadbent at least, an alternative.

Perhaps most interestingly when asked about the major risks to the UK outlook on his pre-hearing questionnaire he responded that:  

The household saving rate is still below levels reached after past recessions. A sudden rise would weaken consumer spending. By draining income and spending power from the UK, higher commodity prices threaten to do the same.

This is very similar language to that recently used by Adam Posen, who told the Guardian that:

“Household consumption is going to be pretty darn weak. It may even contract a little”.

Consumers, he said, were unlikely to run down their savings in an attempt to maintain spending patterns, while the weakness of trade unions meant it would be hard for wage bargainers to push up pay settlements in response to higher inflation.

This is in contrast to the OBR view that:

This subdued consumption outlook requires households to dip into their savings again in 2011, so the saving ratio continues to fall back from its post recession peak. Thereafter, the saving ratio stabilises at around 3½ per cent in our forecast (much the same as forecast in November), which is around half its average over the last 50 years.

If the OBR are right then the household savings ratio will fall in 2011 and then stay low – consumer spending will tick along as required but at the cost of a large build up in Household debt.

If they are wrong (and Broadbent’s,Posen’s and my own fears are realised) then the growth picture just became even weaker.


12 Responses

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  1. Dave Holden said, on May 17, 2011 at 12:19 pm

    Of course the BOE is in an impossible position – but they’re their because of there own and Gordon Brown’s (read Balls’s) incompetent economics. A complete misreading of a bubble in debt – the biggest one in history.

    Again there is no easy way out of this. Osborne’s approach – get a handle on public debt so as to keep interest rates low would be reasonable if any of the private sector debts had been deleveraged – they haven’t. Banks are still using mark to model fantasy accounting that bares no relation to the real value of assets.

    Labour of course don’t have a policy , well not unless you consider the nebulous “cut less quickly” mantra a policy.

    At the moment I favour the IPPRs deficit reduction averaging approach – still painful but it seems a genuine and methodical effort to reduce the deficit in a measured way that would be taken seriously by the markets.

  2. Luis Enrique said, on May 17, 2011 at 12:50 pm

    what is your view of the argument that fiscal stimulous is also inflationary, so that if the government did what most of us want it to do, and cut the cuts, or boost spending, that would also generate inflation putting the BoE under even more pressure to raise rates?

    • duncanseconomicblog said, on May 17, 2011 at 12:56 pm

      Yes – this a worry.

      I’d be in favour of either raisng the target for a time limited period or (better yet) redefining it to exclude externally generated inflation (i.e. commodity price related pressure). Both are difficult in terms of expectations management though.

  3. Luis Enrique said, on May 17, 2011 at 12:52 pm

    nb – given the importance of expectations for inflation, I don’t understand why the bank and others are not trying to spin this – much more loudly – not as inflation but as a one-off increase in the price level (i.e. the VAT increase and imported commodity price increases) that are not going to reoccur year-on-year and wage and price setters needn’t start raising wages and prices each year, as they would if inflation had taken hold.

    of course that could be wrong – commodity prices can keep rising.

    • Left Outside said, on May 17, 2011 at 1:12 pm

      They slipped up big time last year and made a big underprediction for inflation this year. I imagine that has put the bank off longer term predictions for fear of underpredicting two years in a row. That would harm forward looking inflation expectations just as people reassess their predictions of future inflation from two years of above target inflation.

      As expected the former Goldman Sach’s economist took a relatively dovish position on interest rates and inflation and early indications are that he will be closer to arch-Dove Adam Posen than the hawkish Andrew Sentence he has replaced.

      That is good news. More Adam Posens please.

  4. jomiku said, on May 17, 2011 at 4:25 pm

    Why isn’t “cut less quickly” a policy? Is the idea in that comment that Labour must propose something radically different, like replacing the pound with bits of sausage? Cutting less quickly is the rational approach and is a policy. Cutting really, really fast is motivated by belief that somehow there is a reward for radical action, as embodied in the nonsense phrase quoted in the post “expansionary fiscal contraction.” This belief uses a combination of fear – e.g., we’ll be like Greece – and platitudes of the sort mouthed by Chauncy Gardner in the movie Being There.

  5. Dave Holden said, on May 17, 2011 at 6:44 pm


    Cut less quickly isn’t a policy unless it’s associated with some measure of what “less quickly” means.

    See for example my reference to the IPPRs deficit reduction averaging approach – which I first saw on this very blog 😉

  6. Mark Vickery said, on May 17, 2011 at 9:50 pm

    Dave – Osborne couldn’t make a sensible decision in the comfort of opposition and continues to make “political” statements rather than sound “economic” decisions.
    We have had his budget claim of putting fuel back into economy and when he started comparing this recession to the Canadian one in the 90’s claiiming that we should use the same methods of savage cutting to remedy the situation alarm bells began ringing. This is not a normal recession where austerity measures will necessarily work their way through and some flexibilty is now needed else we are doomed to fail

  7. Dave Holden said, on May 18, 2011 at 9:42 am


    I agree. But my view is that neither savage cuts nor cutting less quickly will work when the problem is the ending of a debt super cycle and all the malinvestment it produced. I hope I’m wrong on that.

    I keep asking myself the question – wouldn’t it have been better to just let the banks fail while underwriting deposits. The route we’ve taken means that joe public is paying for the mistakes of bankers through cuts and austerity while central banks print money for those very same bankers to speculate with – keeping their bonuses flowing. The powers that be keep trying to pass this off as a liquidity crisis when its really a massive solvency crisis.

    We’ve gone down the route of moral hazard squared.

  8. jomiku said, on May 18, 2011 at 3:55 pm

    Ah, “malinvestment,,” the keyword of the Austrian believer.

  9. Dave Holden said, on May 18, 2011 at 7:14 pm


    “Ah, “malinvestment,,” the keyword of the Austrian believer.”

    That’s feeble.

    If you must know – I think the Austrian school has a lot to add to the debate particularly in *avoiding* the predicament we find ourself, but I don’t subscribe to it as a *remedy* for it. I don’t in fact have a fixed position as far as economic perspectives go, I’m more a lay person trying to establish one.

    But since you apparently like to project views on to people it might surprise you that for the very specific case we and much of the western world finds itself I find myself leaning more toward the MMT/functional finance approach – but only for the specific case of an ending to a debt super cycle.

  10. Paul Newman said, on May 22, 2011 at 8:00 am

    Your endless calls to borrow more and spend more so at to retain Public Sector inefficiency would confuse if you did not see the purpose which only rhetorical. I really cannot see what you think you are achieving other than muddying the waters. This argument, whilst it may amuse courtiers of New Labour has lost in the country, utterly lost and completely lost.
    Its time to stop sticking your head in the sand Duncan, while you are engaged in a long sulk about your failure the shape of the new model has no left or progressive input at all. Vince Cable was saying something like this today and it is of course is precisely what the Conservative Party did finding itself rejected and despised

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