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”
Anarcho
“However, Keynes argued this was only necessary because of sticky wages – which now you WANT.”
Keynes argued no such thing. His analysis of why a general cut in wages would not increase employment took it for granted that wages could adjust downwards. He argued that if wages fell, then so would prices and so there would be no change in real wages. However, such a cut would impact negatively in effective demand and cause more problems for the economy.
Keynes concluded in “The General Theory” that there was “no ground for the belief that a flexible wage policy is capable of continuous full employment . . . The economic system cannot be made self-adjusting along these lines.” As he summarised:
“the contention that the unemployment which characterises a depression is due to a refusal by labour to accept a reduction of money-wages is not clearly supported by the facts. It is not very plausible to assert that unemployment in the United States in 1932 was due either to labour obstinately refusing to accept a reduction of money-wages or to its demanding a real wage beyond what the productivity of the economic machine was capable of furnishing . . . Labour is not more truculent in the depression than in the boom — far from it. Nor is its physical productivity less. These facts from experience are a prima facie ground for questioning the adequacy of the [neo-]classical analysis.”
The whole “sticky wages” notion was a neo-classical assumption used to explain high unemployment. This was smuggled back into “Keynesian” economics after Keynes died, as part of the neo-classical Keynesian synthesis.
As the Tories subscribe to neo-classical economic dogma, they will be seeking to cut wages in an attempt to reduce unemployment. That will more than likely increase unemployment (it did in 1979 onwards):
http://anarchism.pageabode.com/anarcho/would-cutting-wages-reduce-unemployment
The next few years are going to be unpleasant — unless we are willing to organise and resist the attacks being launched to fix the economic crisis the bankers created.
Tyler
@ FBOT
I have to say, reading your rants do highly amuse me – typical socialist nonsense.
We are a nation of importers….so while you suggest that “evil” corporations like tesco are making out like bandits and screwing the poor worker, what you’ll actually find is that thanks to the >25% drop in sterling, their profit margins have actually dropped. They’ve actually managed to keep prices relatively low, despite everything.
As for sterling itself, it’s hardly surprising it’s dropped. With the budget deficit we have, plus monetisation of it. The UK economy is screwed, and massive government overspending is the cause of it. Not banks, and not the credit crisis.
You are also completely wrong (and Simon T completely right) about what caused the credit crisis. It was CRA96 which created the subprime market overnight. It sparked a massive boom in (unnaffordable) mortgages which relied on cheap short term financing and low interest rates, and ever increasing house prices. When house prices faltered, funding became more expensive and mortgage resets started hitting, the whole house of cards came tumbling down.
Your solution to everything though, as with many on the loony left, is more debt. Even though that debt is going to have to be funded through higher taxes (as we can’t grow our way out fast enough) which slow growth, and the compund interest on that debt will slow long term trend growth even further. The original crisis was caused by too much mortgage debt, and the current crisis in Europe is caused by too much government debt. What is your solution? More debt.
You don’t even know how this extra debt is going to help, other than a hand wavy “extra demand through government spending”, though of crouse, if the money was left in people’s pockets, much of that demand would still be there. It also ignores the most important point, which Greece has found out only too clearly;
What happens when your bond buyers lose confidence in you, because of your massive budget deficits and inability to repay debt?
In reality, you become unable to finance yourself easily, your rates go up massively (which squash growth) and you have to undertake massive internal and external devalutations, like so many countries accross Europe are currently having to do. Cutting the deficit isn’t a choice, it’s the ONLY choice. It’s also one which will help the economy grow faster as taxes will be able to come down long term, rates will be lower and confidence higher.
Finally, that £6bn you talk about isn’t really only £6bn. Its more like £9bn once you include the compound interest…now translate that to the debt we are running up at the moment, and our ability to repay it, and at best you should see how much taxes are going to have to go up (which slows growth) to pay for it, and at worst you can see what a total disaster Labour’s economic management has been, as it will force net spending levels down below 1997 levels before the budget is balanced.
You have a nice day now.
Fat Bloke on Tour
Tyler @ 2.01pm
You are what a dog boiler would call a dog boiler.
Neo classical orthodoxy from start to finish.
Good old time religion it may be but it is wrong from start to finish.
Couple of highlights:
Tesco — What news did their last accounts have on their profits and margin?
CRA96? — The idea that this act has caused the Sub-Prime loan disaster has been refuted “up down and sideways” by people better than me. It really is a piece of Ayn Rand style myth making aimed at deflecting blame. Reverse engineering of the highest order.
The whole idea is so brazen as to be breathtaking — the timing, the scale and the linkage to commercial property suggest that the suggestion is tripe from start to finish.
With regards to the rest of your analysis, I fear that you are another right wing mentalist who would do well to read the Ladybird Book of Economics as you might learn something.
If however you are an academic in the field then I despair.
Consequently away and throw shite at yersel ya muppet.