Inflation trends upwards

After abating in the first quarter of the year inflation has edged up to 3.5%.

Inflation was pushed up by increases in the cost of clothing and food. The uptick in inflation has been imported, but with it I worry  came a dose of timidity for the Bank of England. The Bank  has remained tolerant of inflation but has suffered because of it. I’m known for my dovishness about inflation and these numbers do little to change that.

More domestic demand, even if it results in a little more inflation is just what we need in a depressed economy. But these inflation numbers appear to be little influenced by changes in domestic demand and much of these price increases have been imported. This means they may lead us to be poorer in two ways, one direct, one indirect. Higher import costs are like a supply shock, we really are poorer because of it. The indirect effect is that higher costs still look like the Bank of England is stimulating the economy too much and can lead to the bank doing to little or being actively counterproductive. This is the problem with a central bank targeting inflation. It can be a very, very bad idea as we saw in Europe in mid-2008.

Sometimes inflation increases because that is what getting poorer looks like, things get more expensive. A monomaniacal inflation targeting central bank, for example the ECB under the impeccable Trichet, will take this sort of inflation number as a sign that the economy is overheating, that we are not getting poorer but getting rich too quickly and will act to reduce inflation, usually by throwing lots of people into unemployment. Sometimes by throwing a whole continent into chaos (slow hand clap for Trichet).

Today’s inflation numbers mean nothing in isolation. They are provisional, subject to revision and they refer to an arbitrary length of time with little macroeconomic importance. Nevertheless  they have the power, if they become politically salient, to influence the actions of the Bank of England. These numbers already signal we’re all a little poorer, were the Bank to start to tighten policy today’s numbers could help make us all poorer all over again.

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2 thoughts on “Inflation trends upwards

  1. It is not really right to treat the inflation numbers as “provisional”, CPI is never really revised, and RPI is deliberately fixed in stone since it is used as a benchmark for index-linked gilts.

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