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”
Jacob Williamson
@adamcoomer learn http://ow.ly/1MJjS
Simon Tinsley
@FBOT
Clearly you see the economic analysis as flawed when coming from such a Keynesian perspective, and you argue for demand management. However, Keynes argued this was only necessary because of sticky wages – which now you WANT. The real wage falling is a decrease in the major factor cost and least to an increase in short-run aggregate supply. The economy tends towards full employment and demand management itself only creates inflation in the long-run – as was shown throughout the 60s and 70s.
QE is a problem now – not just in 2012. The inflationary risk was forseen but dismissed that the money would stay within banks in order to bolster their balance sheets, not to fund a whole new bunch of loans, that is the money wouldn’t ‘leak’. It has – how else do you explain the increasing inflation month on month. After all, the VAT increase is fixed from when it went back up in January, the power of Tesco is just frankly crap – oligopolistic market structures breed price stability and the oil price is historically low – it is running at $85/barrel. Your speculation is wrong. If you increase the money supply (M4) as they have by 10%, then to not expect inflation is madness. It is clear it is having an inflationary effect. You can also see the effect on the value of the pound in currency markets, Sterling has depreciated rapidly since the start of the programme, it is clear it is having an effect now.
The way to get money moving again is to increase business confidence. Currently, business confidence is not shot because of economic downturn, but because of the threat of higher taxes because of the huge deficit. That is the biggest threat to business confidence and taxes are the problem, not the solution. If there are high levels of business confidence it does not matter that people are saving – as businesses will take advantage of the lower interest rates to invest. Of course, if business confidence is low, because of fear of future tax hikes, then it becomes a problem. Once again – it stems back to the deficit.
It is not the governments that solved the problem caused by unrestrained capitalism, but governments that caused the problem in the first place. As Gordon Brown is so keen to say – the problem came from America. The sub-prime crisis was caused by the 1996 Community Reinvestment Act which forced banks to lend to poorer people or face sanctions. These are the very people who couldn’t pay the money back as interest rates rose to counter the increasing inflation. The increase in default rate is amplified by structured finance and hey ho we have a credit crunch. The origins lie with the government of the USA under Clinton.
That and poor regulation of the banks (and believe me it will only get worse after this crunch), pushed banks into riskier and riskier corners in the investment sector, as regulation does. So – to paint governemnts as the saints and capitalism as the devil is the wrong way around. If you create perverse incentives, you will get unintended outcomes, and perverse incentives led to systematic malinvestment, the driver of most recessions. The cause? Government.
The NI rise is just as damaging. After all, it would cost 57,000 jobs. It’s hardly the way to stimulate a recovery, increase costs to businesses and stifle supply just when it costs to businesses need to be lowered. Creating a high-cofidence low tax environment should be the key to any recession, you cannot spend your way out of recession and you cannot borrow your way out of debt.
The £6bn is token, but it’s £6bn better than nothing. As I stated above to spend £6bn you must take £6bn, either through tax, borrowing or printing money (the inflation tax). A return to the gold standard is not necessary – but growing the money supply in line with increases in output is all that is required, inflation causes distortion in the price signal and as policymakers have realised this world inflation has fallen dramatically.
As for Hoover’s failure to steer the US out of the great depression – I’d look toward the Smoot-Hawley Tariff Act and subsequent retaliations, it was a huge barrier to getting out of the depression. Imports and exports dropped by 60%, and the mutual benefit of trade was lost.
Michael Burke
The mistake on monetary policy headline is not such a gaffe; Osborne has incorporated that error into policy. That is, he repeatedly refers to looseness of monetary policy as obviating the need for stimulus and allowing cuts.
But monetary stimulus is not working or is workig perversely. A weaker pound is not producing increased exports because investment has collapsed, off-setting the improvement in competitiveness. Lower short-term interest rates are merely serving to bolster asset prices and not productive investment. The upshot of a weaker pound, higher import prices and higher asset prices is rising prices, not increasing activity.
For sure, depressing demand further by fiscal tightening should alleviate some of those inflationary pressures. But any sustained recovery is likely to be a weak export/high inflation one, pushing the Bank to hike rates sooner rather than later. Fiscal and monetary tightening, the worst of all worlds.
Fat Bloke on Tour
Simon T @ 8.18pm
Thanks for the reply, it makes for interesting reading.
However, as they say, if you give some people enough rope and they will hang themselves and you certainly managed that.
Consequently, best of luck with your A levels.
Now the detail, most of what you write has the pungent odour of reverse engineering hanging over it as you desperately thrash about looking for excuses to get the banking sector and casino capitalism off the hook regarding the Credit Crunch.
Para 1 — Could you please re-write as it doesn’t currently make sense.
Para 2 — Inflation is rising because of the issues I raise, low inflation months are falling off the annual measure so any rise is running straight through to the headline figure. Regarding specifics:
Oil — $85 per barrel is high.
Food — Tesco et al are having a good recession, they have managed to pass on the low pound inflation and then some. If Sniffy and his wrecking crew manage a double dip then they will find it a lot harder than the last 15 months but so far they have played a blinder.
Pound — The 25% devaluation of the past 2 years was caused by the end of the yen carry trade / Sterling chapter. The ups and downs of the past 6 months are the normal gyrations of a currency market in full coin clipping mode. That is generating turmoil so that they can turn a trick.
Para 3 — Orthodox tripe, confidence is low because of the current low levels of business activity. Low demand is the issue not the threat of high future taxes.
Please remember a horse struggles to push a cart.
Para 4 — Best bit of reverse engineering so far.
Straight out the US rabid right wing of excuses, Slick Willie did it and he ran away.
10 year gap — Don’t talk about it?
Derivatives — Turning shite into gold at the pressing of a button?
Sales Tactics — Teaser rates, they are the future you know.
Structured Finance — Bloody do-gooder liberals again?
Para 5 — What are the perverse incentives you talk about?
Business rule No.1 — Don’t go bust, when did the government outlaw this?
Para 6 — £6bill efficiency savings, first up is the figure net or gross?
57K job losses = 23K job losses from the original study plus the fiddle factor that Dave the Rave ordered them to use. You really couldn’t make it up, I wonder where Sniffy got the idea about politicians fiddling statistics.
Please set this against the job losses that the £6bill of savings will produce, 60-80K would be my guess.
Also the NI rise comes in during April 2011, another 11 months to see how the recovery is developing.
Para 7 — Let you in on a wee secret, the return to the Gold Standard is only the start.
Next up will be the economic efficiency of Continual Indentured Servitude / CIS.
I have it on good authority that Niall F will be pushing this as the next stage in Workfare — CIS / Neo slavery as it is called by the true believers.
Sniffy will sell the unemployed to Hedge Funds who then have full income rights till retirement age on payment of the dole + 2000 calories per day.
The legals tell me that Justice McCombe will make sure that the civil liberty issues are sorted and we should be good to go.
In fact a certain Mr William Walsh could well be the first customer as he will have few vacancies once he has effected a large scale rapid transition strategy onto his existing workforce.
That is the great advantage of “Dog Boiling”, once you have persuaded the poor and the unemployed that sustenance for them and their family lies in cooking the family pet all sorts or wonderful opportunities open up for the upper middle class establishment politician with an eye for the perfect efficiency of markets.
Para 8 — We live in interesting times.
Tariff reform is out there on the back burner, for now.
As the 1930’s showed, put enough stress on the population and anything is possible.
Consequently away and bile yer heid ya numpty.
Surely you can get the Ladybird Book of Economics in Tonbridge Wells.
Fat Bloke on Tour
MB @ 12.02am
Low pound provides two boosts — import substitution + increased exports.
We do not need investment at the moment, the current low levels of activity mean that we can sweat what we have to get things started.
Biggest plus in all this would be a change in attitude.
Manufacturing lost out to the city at every level.
New blood will help turn around the old managed decline ethos.
In addition immigration will help as more people who see making things as a career become available rather than the old British upper middle class attitude that it was somehow beneath them to get their hands dirty, all a bit too much trade for their liking
Inflation is being supported by one of the effects of the credit crunch, the survivors have less competition and are trying their luck with putting up their prices.
Also in the housing market activity is the issue not asset price inflation. Lack of buyers meant that prices fell due to the need of distressed sellers to sell at any price.
Non distressed sellers just sat tight and waited for mortgage lending to improve.