The new Chancellor of the Exchequer, George Osborne, received a letter from the Governor of the Bank of England today, explaining the latest rise in inflation.
The new Chancellor of the Exchequer, George Osborne, received a letter from the Governor of the Bank of England Mervyn King today, explaining the latest rise in inflation. Official figures from the Office for National Statistics (ONS) show consumer price inflation increased to 3.7 per cent in April, while retail price inflation rose to 5.3 per cent, its highest rate since July 1991. Consumer price inflation has now been 1 percentage point or more above its target rate of 2 per cent for four consecutive months.
The Governor was able to point to some special factors that have boosted inflation in the UK, including the increase in the standard rate of VAT from 15 per cent to 17.5 per cent in January, record petrol prices and the lingering effects of sterling’s 25 per cent depreciation in 2007-08 (though the last should have just about worked through the system by now).
He also reiterated the Bank’s view, expressed in last week’s Inflation Report, that inflation will fall sharply in the second half of the year. But it is an uncomfortable fact that prices in the UK have been increasing far more rapidly than the Bank, or indeed most other forecasters, expected.
This is important for three reasons.
First, the Chancellor’s plans to make savings of £6 billion in public spending in the current financial year are predicated on the assumption that monetary policy can remain extremely loose well into 2011. If the Monetary Policy Committee thinks inflation expectations are increasing, as a result of high recorded inflation, they may have to rethink the timing of the first moves to reduce quantitative easing or increase interest rates.
If so, the economy could face a simultaneous monetary and fiscal policy squeeze at a time when the recovery remains very fragile.
Second, wage inflation is very low, so high price inflation means real wages are contracting. Unless households are prepared to save less or borrow more – and the Conservatives believe that the opposite is desirable – consumer spending will grow very little, and could contract, in coming quarters.
As a consequence, the economic recovery could fail to pick up momentum and may be at risk of stalling.
Third, Mr Osborne may be contemplating an increase in VAT and/or in other indirect taxes in his ‘emergency Budget’ on June 22. To do so while inflation is already at uncomfortably high levels would be to increase the risk of weaker growth in the short-term and of higher inflation expectations in the medium-term.
Not a good first move as Chancellor.
It is, perhaps, natural for a new Government to want to be seen to be putting its own stamp on economic policy as soon as possible – but the economic situation in the UK is very delicate and argues for extreme caution in coming months; the less that is in the emergency Budget, the better.
UPDATE 12.42:
Thanks for the comments. The headline should, of course, have read “fiscal policies”. A monetary (sorry, momentary) lapse.
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33 Responses to “Osborne’s fiscal policy risks stalling recovery”
tomtiddler
i think a worst case scenario is a sovereign debt downgrade (likely after the PIIGS we bailed out for 3 years). this would mean higher interest rates, and high inflation. the labour government really did it to us bad this time.we may be looking at 10-20 years of stagnation (happened to Japan, stock market still only 25% of peak). we should have paid down our debt from 2000-the crash. we paid off a bit when they stuck to conservative spending plans but after that they went crazy. taxes rose 36->38% GDP, spending rose 36%->48% GDP. That is just f*cking crazy! now you can say we have better hospital and school buildings – they aren’t even counted, that’s PFI. you can say we have more nurses, doctors and police – they are going to be paid for by your children you greedy lazy socialist c*nt
Roland M-Horne
RT @leftfootfwd: CORRECTION: Osborne's fiscal policy risks stalling recovery: http://bit.ly/90vLeU
Rashidi Abu Bakhar
Is the headline not wrong? Should read fiscal, not monetary. Gideon does not run monetary policy, no?
Simon Tinsley
1. Osbourne doesn’t have control over monetary policy – that is in the hands of the BofE – so the title is an oxymoron. HM Treasury has control over fiscal policy.
2. Real wages are contracting, yes. This is necessary to reduce the factor costs, and thus short-run aggregate supply to the right. It is the economy re-adjusting. I’m afraid that huge government intervention has created a very rigid Labour market, so this has taken longer than expected.
3. The £6billion of savings are not a threat to the recovery, but the opposite. To spend that £6billion the government must get it from somewhere, they must either raise tax or borrow it. You either take money from people who would spend it, or from people who would invest in other things apart from government bonds. To spend the £6bn, you must first take it out of the economy. It is a leakage before it is an injection. Once again I leave it to the ASI for more detail: http://www.adamsmith.org/blog/tax-and-economy/that-%C2%A36bn:-a-lesson-in-economics/
4. By far the largest threat to our recovery is a sovereign debt crisis, and with the events in Greece sharpening the focus of investors and rating agencies, we must bring spending down ASAP. After all, our budget deficit is higher as a proportion of GDP.
5. While I agree that an increase in VAT is a bad manoeuvre, he is tied politically to raising tax rather than cutting spending at least in some part. As you well know – the VAT rise is just speculation currently based on some economists predictions. As everyone knows, take two economists and you have three points of view.
5. It is no surprise that inflation is occurring after the BofE created £200bn on money out of thin air. That’s the driver behind inflation, and to continue with QE will only drive further inflation.
5. Extreme caution means staving off the biggest threat to our economy, a sovereign debt crisis. As such, if he is to be extremely cautious, he should slash spending. Rather a different conclusion than you were coming to.
Andy Sutherland
RT @leftfootfwd: CORRECTION: Osborne's fiscal policy risks stalling recovery: http://bit.ly/90vLeU