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.
33 Responses to “Osborne’s fiscal policy risks stalling recovery”
Fat Bloke on Tour
Simon T @ 12.30
From what I have read of your analysis your counting skills, flawed though they may be are far ahead of your economic sentiments.
You really need to move on from the ASI when looking for support to your opinions, the report on Treasury forecasting you mentioned isn’t worth the fag packet it was written on, partial, slanted and wrong is only the half of it.
Today’s ASI report is simpler but just as wrong, we currently have a private sector surplus and a public sector deficit. They are two sides of the same coin, the paradox of thrift is being played out up and down the country and we now currently have the state as the spender of last resort.
Take that away or reduce it and things will only get worse, aggregate demand will fall and the savings rate will improve.
Regarding specifics:
2) Current inflation is down to the VAT increase, the power of Tesco and the remnants of the currency induced import price rises most notably oil. We need real wages to be stable so that demand does not contract further. As for the rest of your thoughts I just don’t get it, do you really want real wages to fall further?
3)Fairy story by the ASI, we currently have tghe reverse multiplier at work along with a significant reduction in the velocity of money. If things get much worse and the private sector surplus gets much larger and the savings rate stays high the best solution would be to tax and spend to get the money moving again.
A bit retro but needs must if we are to stop a potential double dip becoming a death spiral.
AD built the foundations of a recovery, Dave the Rave and Sniffy have turned up with a demolition crew, not the squad of brickies we need.
4) Sovereign debt is a symptom not the cause. The Credit Crunch was generated by wasteful investment in the private sector along with a large dose of casino capitalism to amplify the problems.
2008 = Governments were the lenders of last resort.
2009 = Governments were the spenders of last resort.
2010 = Governments get the blame, no I don’t think so.
It ill behoves the markets who caused the problem in the first place to criticise governments who cleaned up the mess.
It reminds me of the attitude in the 13 Colonies circa 1770.
You have saved us from the bogeyman, now we don’t need you any more we will get rid of you.
5A) VAT rise is Plan B, the NI rise should be Plan A.
The £6bill of cuts / efficiency savings mentioned by Sniffy is just a case of a dog boiler firing up the chainsaw for a bit of slash and burn, political mood music that will sink us all.
5B) Crap, crap and more crap, please see the first VAT increase, the power of Tesco and the last dregs of the low pound import price rises and the rising cost of oil. QE is 2012’s problem.
5C) Herbert Hoover rides again, dog boiling back on the menu, you couldn’t make it up. When will a return to the Gold Standard come back onto the agenda?
Jacob Williamson
RT @leftfootfwd: CORRECTION: Osborne's fiscal policy risks stalling recovery: http://bit.ly/90vLeU
SCUBA junkie
Osborne's fiscal policy risks stalling recovery | Left Foot Forward: Published by Tony Dolphin, May 18th 2010 at 1… http://bit.ly/csXVQU
tom serona
Osborne's fiscal policy risks stalling recovery | Left Foot Forward: The new Chancellor of the Exchequer, George O… http://bit.ly/csXVQU
Jacob Williamson
the risks of contractionary fiscal policy when a monetary squeeze might be necessary for inflationary purposes #torycuts http://ow.ly/1MJjS