Inflation

 

                 How much more inflation will it take to get the Monetary Policy Committee to notice it? The recent producer price numbers show increases of more than 13% in the costs industry is incurring, and inflation of output prices by almost 5%.  As a contributor to this site has asked, what is the point of the MPC other than to prevent this kind of thing happening?

               The Bank’s defence is that it cannot be expected to offset increases in world commodity prices, including oil, metal and food. It sees these increases as outside their control, and assumes they will subside as quickly as they came about. The Bank slides over the role of weaker sterling in increasing our prices, ignores the fact that other western countries facing similar increases in world commodity prices are not experiencing the same increases in their general price level, and glosses over the period of  more than a year now when they have been saying this is temporary.

             I have a further worry. Maybe these commodity price rises will come to an end when the US stops printing dollars, and as the Chinese and Indian monetary tightening has more impact. The UK, however, faces structural price rises in energy costs in the years ahead, as it brings in the full carbon price regime and more expensive ways of generating electricity. The whole of western Europe faces higher costs of doing business, as the regulators introduce many more ways to make manufacturing in the EU dearer.

          The UK government wants to rebalance the UK economy, placing greater emphasis on making things. Last year we imported £96 billion more goods than we exported, so there is plenty of scope to do so. British business could both sell more abroad, and replace more of the imports with domestic production.

               Quite often people think the difficulty in the UK is relatively high wages. For much modern manufacturing wage cost is not the main issue. Processes are highly automated. It is the costs of bought in materials and energy that are more important. Location decisions rest on transport, power and access to materials, as well as the ability to recruit a good workforce.

              To bring about the transformation of the UK economy the government seeks, with bigger and stronger industry spread out around the country, business needs access to plenty of good value power, good transport for exports and imports, and access to plentiful capital to buy the plant and machinery needed.

             There is more to be done in all these fields. A local company recently asked me to intervene with the power utility to get access to the amounts of power they needed – and that was not process industry burning large amounts of energy.

             Hitting our carbon taregts by exporting more of our energy intensive industry to places where energy is cheaper neither saves the planet nor transforms our economy.

             The deficit reduction measures are already having an impact on real incomes, as this year all the strain has been taken by the private sector through a series of tax increases. Next year the slower rate of growth of current public spending does bring some areas of reduction, to offset the more rapid growth in the preferred programmes. The degree to which the cuts do damage depends entirely on how the public sector manages the change from rapid growth in cash spending to slower growth in cash spending.

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34 Comments

  1. Stuart Fairney
    Posted February 12, 2011 at 6:47 am | Permalink

    Yep, the turkeys are coming home to roost on all the green stuff and electricity, (when it is available and it won’t always be) is going to be very expensive. Perhaps you could tell Mr Huhne if he’s not too busy in his personal life or having really important discussions in Cancun?

    Given that you apparently accept that regulatory costs are;

    (a) pointless
    (b) harmful to UK business

    Why are you still in the conservative party which seems not to realise this?

    • Posted February 13, 2011 at 11:33 pm | Permalink

      Stuart,
      The argument for tackling climate change is
      “We take a large amount of cost now, or leave subsequent generations to suffer a greater amount of cost and suffering later”
      The Stern Review claimed that the benefits exceeded the costs by 5 to 20 times. Tackling climate change becomes a cost-minimization strategy. Whatever the doubts one might have about the validity of the conclusions, if we implement choose cost-inefficient policies then we impoverish ourselves and future generations. If they also not effective in constraining CO2, then we leave future generations much poorer and thus less able to cope with a warmer climate and the scourges that will bring.
      Our current policies fail on both grounds. They do not constrain costs within the worthwhile limits, and do not go anywhere close to cutting the UKs CO2 emissions by 80%.
      For anyone interested, I try to put the Stern Review argument into a simple graph.
      http://manicbeancounter.wordpress.com/2011/02/11/climate-change-policy-in-perspective-%e2%80%93-part-1-of-4/
      I then look at why the political process is largely unfit for purpose.
      http://manicbeancounter.wordpress.com/2011/02/13/climate-change-in-perspective-%e2%80%93-part-2-of-4-the-mitigation-curve/

      • Mark
        Posted February 14, 2011 at 3:29 pm | Permalink

        Tell it to the Chinese – now the world’s second largest economy, and biggest CO2 emitter.

  2. Mike Stallard
    Posted February 12, 2011 at 7:20 am | Permalink

    Wherever the government intervenes, it makes things worse.
    Education, marriage, railways, libraries, money markets,employment and national insurance are all very good examples. Yesterday a man in a stripy suit came on the TV from Luton actually saying that pouring money into BSF with more PFIs would bring the economy out of recession! As if.
    Inflation is the result of big, interfering, blind government. Free us English up and let us work, for heaven’s sake! We are a good, hardworking, industrious and imaginative people if we are not constantly held down by idiots and jobsworths.

    • Posted February 13, 2011 at 4:00 pm | Permalink

      I believe that the reason government makes things worse is it is deemed sufficient to see an issue and make an an argument to take action. Schools were old and were that nice to be in, so we scrap the lot and replace them. Doctors and nurses are fairly poorly paid, so we give them a 50% pay rise. The economy is in a fragile state, so we should keep interest rates low and not increase taxes and cut expenditure.

      It is not asked, with some degree of impartiality, whether the actions that government have a reasonable expectation showing a net improvement.

      We have a lot of new schools and hospitals which is nice. We have much better paid nurses, doctors and other vital people which is also nice. Most normal people do not want to inflict the pain of redundancy, or to reduce useful services. We have just come through a severe recession, with some of the worst consequences, at least temporarily alleviated by very low interest rates.
      But we also have a huge deficit, a rapidly rising national debt and rising inflation. All have come about from looking only at the (possible) benefits and not looking at the likely costs. Delaying reducing the deficit WILL cause the structural deficit to rise. Delay also runs the risk of much emergency bigger cuts in the next downturn. Failing to control inflation risks of stagflation and reduced growth, which means a bigger fiscal squeeze. We take a large amount of pain now, or much bigger one’s later.

  3. Steve Cox
    Posted February 12, 2011 at 8:05 am | Permalink

    Jeremy Warner wrote an excellent piece a few days ago succinctly summarising the Bank’s failure in the Telegraph:

    http://www.telegraph.co.uk/finance/comment/jeremy-warner/8314423/Housing-is-in-need-of-some-shock-therapy.html

    He makes some salient points very clearly. For example:

    “The intention is to spread the household adjustment over a period of years, so that its impact on jobs, consumption and confidence won’t be so bad. But if the consequences of that policy are that savers get hammered, the Bank of England’s credibility goes out the window, and there is a further loss of economic competitiveness, you have to wonder whether it is a price worth paying.”

    and:

    “Whatever the solution, deliberate destruction of savings is no way to run an economy.

    He followed it up this morning with another good piece:

    http://blogs.telegraph.co.uk/finance/jeremywarner/100009489/why-the-bank-of-england-has-got-it-so-hopelessly-wrong-on-inflation/

    The conclusion is very interesting:

    The Bank of England likes to distinguish between domestically generated inflation, which monetary policy can influence, and externally generated price increases, which it cannot. According to insiders, it has as many as three different measures of domestically generated inflation, which basically tells you all you need to know – that distinguishing between the two in any meaningful way is virtually impossible. Inflation is inflation; it’s that simple.

    Or as DeAnne Julius, a former member of the Bank’s Monetary Policy Committee put it this week at Fathom Consulting’s monetary policy forum: “It’s fanciful to think you can control the domestic side and ignore the external shocks.” Quite so.

    Perhaps those concerned about high inflation, the Bank’s evident inability to even start to get to grips with it, and the Chancellor’s apparent lack of interest in the issue, would like to copy a few of the salient points from Jeremy’s articles and John’s here and send them to their MP via

    http://www.writetothem.com/

    It’s free and easy to use. They also keep track (with your help) of whether the MP replies, so you’re more likely to get a response. You can also see how responsive your MP has been to other people writing to them from your constituency. Remember, for every constituent who makes the effort to write a letter, MPs often assume there are many more constituents who are concerned about that issue, but don’t bother writing. So every letter counts.

    Apologies for harping on, John, but I don’t see any other way for us ordinary folk to influence what is going on.

    • Stuart Fairney
      Posted February 12, 2011 at 4:16 pm | Permalink

      From your last paragraph, delete the word “other” and you are entirely correct.

  4. lifelogic
    Posted February 12, 2011 at 8:23 am | Permalink

    “Nothing short of real democracy” for Egypt says Obama – could the UK try that too soon please.

    Manufacturing (and indeed industry) needs cheap energy, simple planning laws, available capital, supportive government at local and national levels, a good affordable skilled determined workforce (who can be fired when needed), easy employment laws, simple and low taxation, efficient local suppliers, a buoyant local market.

    The UK provides pretty much the opposite on every single one of the above. Anyone who reads the employment, equality, environmental, health and safety and tax laws for business in the UK and is not deterred from a UK manufacturing base is probably a fool. Anyway he will have not have any time to run the business as these alone will take up all his time and money. The best advice is probably to get a job as a lawyer or in government H&S or tax usually attacking and destroying such industries in one way or another for a high wage and a good pension.

    • lifelogic
      Posted February 12, 2011 at 9:32 am | Permalink

      Ken Clarke warns of “the calamitous” state of the economy and says he does not envisage “a quick rebound”.

      Certainly not with the current big state, expensive energy, pro EU and over regulation of everything policies that he usually espouses.

      Also Polly Toynbee on any questions last night (who is always amusing) “radio 4 is fantastic, amazingly rich and varied”. I can understand why she likes it – it paid her and politically it is pretty much Polly Toynbee/Guardian/big state/over regulation/voice of the state sector type radio from start to finish.

      Varied politically hardly.

      Last time I heard Polly the great “thinker” she was most concerned about getting cleaners in London after the housing benefit changes I do hope she is managing OK.

      • Bazman
        Posted February 12, 2011 at 7:46 pm | Permalink

        Apparently Ken Clarke says that the effect of the cuts is lost on the middle classes. Very interesting. Got to respect ‘Ken’ QC. I did see Vince Cable like this, but he sold out.

  5. JimF
    Posted February 12, 2011 at 8:28 am | Permalink

    Yes, all that and add on the inflationary increase in taxes on business. We are now beginning to see customers abandoning products they have bought in the past, where the input costs of processes, materials and labour have meant almost doubling Sterling prices in comparison with 5 years ago. We still have enough work to cover our costs and make a reasonable profit, and we have no desire to dramatically increase our workforce. Frankly, busting a gut to keep this type of business at a lower price, taking on extra labour etc. only to end up with worse cashflow and more worry isn’t worth it in this environment.

    Perhaps you could put yourself forward to do a study on the impact on business of coming out of the EU? The rules and regulations you speak of are mainly EU inspired, and taxes could be reduced were we outside the EU. Why can’t your government put forward a 5-year plan to reduce regulation and taxation on business?

  6. Alte Fritz
    Posted February 12, 2011 at 8:32 am | Permalink

    As a layman, the argument for nuclear seems unanswerable. The French seem to find it attractive. Can we not learn from them?

    A friend of mine runs a real world beater in the field of energy efficiency. The world beats a path to his door in Lancashire.

    We can do it if we want to.

    • grahams
      Posted February 12, 2011 at 7:05 pm | Permalink

      Supposedly, Electricite de France has been given the go-ahead for a new generation of atomic plants but not a lot is happening. I do not think the anti-nuclear elements in the regulatory regime have yet been negotiated away with that nice sympathetic Mr Huhne. A “pre-planning application” for Sizewell C (first turned down by the Major government in 1993) is pencilled in for June, then curtailed public consultation, then detailed planning permission, then improved access roads (not yet even proposed). If all goes well ( big if) no start until later in 2003 and no power until next decade. Meanwhile, we will probably depend on continued recession in industry to avoid power shortages after 2015.

  7. GJ Wyatt
    Posted February 12, 2011 at 8:42 am | Permalink

    The trouble is that the majority on the mpc is sanguine about inflation, and so is the government. Too many mpc members think we are suffering from insufficient aggregate demand despite the evidence of a widening balance of payments deficit coinciding with a weak currency. For the government inflation is a surreptitiously convenient means of reducing its debt, which also reduces the value of private savings. Requiring the governor to write an open letter to the chancellor is not enough of a sanction on the “operationally independent” Bank of England. There should be a public debate and an open procedure for replacing the non-performing mpc.
    But it is a big problem for the people

  8. alexmews
    Posted February 12, 2011 at 8:57 am | Permalink

    off topic but some interesting data on the numbers and geo-distribution of those paying the 50p income tax rate. the article claims 275k people will pay it and, separately, 1% of income tax payers – those earning more than£1M – will pay 25% of all income tax next year. half of all 50% rate tax payers live in London / SE. Unlikely this policy is going to attract more of these people, or encourage the circumstances where people will work harder to join theor ranks!

    http://www.ft.com/cms/s/0/969a605e-3616-11e0-9b3b-00144feabdc0.html#

    • David John Wilson
      Posted February 13, 2011 at 12:11 am | Permalink

      Firstly 1% of tax payers earn more than £100,000 not more than £1M. Secondly those tax payers will pay much less than 25% of the total income tax take. Even if they paid 100% tax on all income over £100,000 they would only pay about 25% of the total income tax. It is a complete fallacy to imagine that taxing the top 1% of earners a higher rate would make a huge difference to the total tax take. There are too few of them to make a significant difference.

  9. Brian Tomkinson
    Posted February 12, 2011 at 9:28 am | Permalink

    Time to recall Reagan’s words again:

    “Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.”

    “The problem is not that people are taxed too little, the problem is that government spends too much.”

    “The most terrifying words in the English language are: I’m from the government and I’m here to help.”

  10. norman
    Posted February 12, 2011 at 9:31 am | Permalink

    I’m sorry, I have to disagree with the last sentence. If we push ahead with the green madness to the extent that is proposed I have no doubt it will transform our economy.

  11. waramess
    Posted February 12, 2011 at 9:46 am | Permalink

    Much less tax, much less regulation, much less government, job done but an inconvenient truth

  12. Acorn
    Posted February 12, 2011 at 9:52 am | Permalink

    The US money printing is effectively exporting inflation to the rest of the world. All that stimulus gets transmitted via globalisation to the emerging economies in a tsunami of dollars. The EMs desperately try and stop their currencies appreciating to keep their exports going and end up re-exporting their own supply side / wage inflation back to the US and other deficit, high unit cost countries, like the UK.

    Eventually, paying a million dollars for a one bedroom flat in Beijing, may start to look like mal-investment. But, if you are a commodity producing country, you are laughing; for the moment. The UK needs a massive increase in its productive capacity and its productivity. If only to help keep down internal inflation.

    Forget the crap about selling off forests; kowtowing to supranational organisations and tree huggers and concentrate on what matters. We can come back to those things when we are rich again.

    PS. To Hamada in Egypt. Hope all your Nile cruise boats are still afloat. The tourists will come back.

  13. oldtimer
    Posted February 12, 2011 at 10:32 am | Permalink

    It is extraordinary that the government still insists on imposing inflation on consumers and businesses energy costs via the measures set out in the Climate Change Act and elsewhere on the basis of an unproven hypothesis about man made climate change. Add to that the high levels of personal taxation now inflicted on go getting high earners, I do wonder why anyone should bother to try too hard here in the UK. It would be wiser for them to apply the precautionary principle and set up in business elsewhere.

  14. Posted February 12, 2011 at 10:37 am | Permalink

    This is an age old ploy, ably promoted by mandarins to inflate away public debt. It is little more than a punitive tax piled on top of all the other taxes. Clarke’s warning today is more chilling than he realises. The Egyptian people have shown the way why should Western peoples not do so as well?

  15. StrongholdBarricades
    Posted February 12, 2011 at 11:02 am | Permalink

    Hitting our carbon taregts by exporting more of our energy intensive industry to places where energy is cheaper neither saves the planet nor transforms our economy.

    I thought this was government policy?

    Maybe we also need to grasp the nettle that is power production, and rethink a policy so that the government could build a power station, and then sell it on to the highest bidder.

  16. Javelin
    Posted February 12, 2011 at 11:33 am | Permalink

    The reason I think the MPC has got it wrong is the reason they say they will not raise interest rates is the fear of a double dip recession. What they don’t get is that there is going to have to be significant cuts to the public sector for many years, and as such there will be the risk of a double dip for many years. They must focus on their task of maintaining inflation and not of maintaining growth or the GDP. The GDP will fall because of the need to cut the public sector. The private sector will grow and wages will then grow to meet inflation. Again, the MPC must be reminded their remit is to keep inflation down and NOT GDP up. GDP will be looked after by the politicians and not them.

    • Mark
      Posted February 12, 2011 at 11:11 pm | Permalink

      The policy of extreme afterburner injections from QE to try to accelerate demand and prices in the economy are almost guaranteed to cause the economy to stall in flameout stagflation later.

  17. grahams
    Posted February 12, 2011 at 3:17 pm | Permalink

    The MPC is storing up big trouble for the future. The aim of the policy was to reduce inflation expectations. They more or less reached the inflation target but now, on the Bank’s own survey, people expect almost 4 per cent inflation next year and well over 3 per cent in the long term. A big problem if and when the economy returns to “trend”, if there is such a thing.

    To be fair, CPI inflation has been boosted by about 1 per cent since the start of 2010 because of VAT rises. This element may well be temporary but as the producer prices indicate, there is plenty more in the pipeline.

    The MPC seems to draw no distinction between low interest rates, which are appropriate, and emergency rates which have become destabilising.

    The Bank now seems scared to raise rates, even though this would probably be a net benefit to business by encouraging slightly higher risk lending.
    The fear is simple: the impact on the budgets of mortgage borrowers and, to a lesser extent, house prices.

    Maybe this is what Mr Clarke was referring to in his warning to “the middle classes”. But this problem will not go away for several years so the longer action is put off the more painful it will become and the more higher inflation will become entrenched.

  18. zorro
    Posted February 12, 2011 at 5:53 pm | Permalink

    The government has shown it is rather flaky in its defence and subsequent rout from promoting more private trees and forests. It does not bode well for anything. As other contributors and I have stated, it is clear that this government does not understand how to promote growth or cut spending.
    It is hang in there and hope. Either there is a covert strategy to try and fool people that they are serious about inflation whilst at the meantime accepting 5 or 6% (and the rest) over five years and inflating away the debt with a cash flat strategy or they are totally incompetent.
    My experience of the public sector is that either one (or both at the same time) of those options is possible.
    I think that Mr Clarke may be stating that there will be many hard years to come. That may be true but this coalition will be toast well before that.
    Hands up who thinks Cameron et al will cope with millions (hundreds of thousands) on the street when they realise that they are being taken for mugs and we have no hope of (real) recovery…..

    zorro

  19. zorro
    Posted February 12, 2011 at 6:51 pm | Permalink

    ….And the main reason for the covert (hahaha) inflating of the debt is that too many households are prisoners of overinflated house prices. If they default, the banks go down.
    0.5% interest rates are a frantic and futile attempt to allow people to pay off their over-inflated house prices. The market is completely rigged. If it was free, house prices would tumble.
    The government are taking savers for suckers. The banks are being allowed to borrow money at 0.5% and then charge usurious rates to private lenders (lending to businesses is too complicate for modern banks it seems….) and make fake profits.
    The grand scheme in a nutshell. My Hobbesian view of the world is well justified. Thankfully, I got a tracker when I realised their scheme whilst buying as much gold as possible to protect the value of my savings.
    John, as you suggested at the time, there should never have been a bailout. We could have shaken out the debt and bad banks. Unfortunately, the ‘metropolitan elite’ (or whatever collective noun/secret society name you wish to use) have their own agenda and masters….They have sold their souls….
    They will ultimately fail, and I only hope fate deals them what they deserve.

    zorro

  20. Andrew Gately
    Posted February 12, 2011 at 7:27 pm | Permalink

    Whilst I agree that the MPC should now be raising interest rates I don’t think they should be straight jacketed by the 2% inflation target.

    The 2% target was set when china was exporting deflation and may not be able to be achieved in the current enviroment no matter what the interest rate.

  21. Posted February 12, 2011 at 10:13 pm | Permalink

    Everything you say is true, so why aren’t government ministers doing something about it?

  22. Posted February 12, 2011 at 10:50 pm | Permalink

    Completely right, John. Especially the bit about the problem with British industry not being high wage costs.

    Germany has much higher wage costs than Britain, but has run a huge trade surplus for decades.

  23. Mark
    Posted February 12, 2011 at 11:21 pm | Permalink

    Mystic Merv presently seems more preoccupied with concerns of solvency of the banking system rather than worrying too much about such trivia as inflation:

    http://londonbanker.blogspot.com/2011/02/mervyn-king-from-bagehot-to-basel-and.html

    He’s right to worry. There’s an even bigger head of bubble steam in commodities markets than we had in 2008 if we measure by open interest on futures exchanges. It may only take one forced position liquidation of large size to crack the whole bubble. Perhaps that”s why he’s less worried by commodity inflation. Massive see-saw volatility will catch many out. The associated uncertainties do nothing to promote investment.

    Your post is once again on target with its analysis.

  24. Lindsay McDougall
    Posted February 13, 2011 at 10:45 am | Permalink

    Blaming a general price rise on particular price rises is the oldest trick in the book and is the hallmark of a desperate charlatan. If money supply is under proper control, above average increases in some prices are balanced by below average increases in other price rises.

    For the umpteenth time, we need a new Govenor of the Bank of England and a new MPC, ones that stick strictly to their remit. This is not America. We have an inflation target, not an inflation and growth target.

  25. sm
    Posted February 13, 2011 at 12:07 pm | Permalink

    In my opinion ,once the banks are fixed, interest rates will rise harshly, but when will the banks be fixed?

    Withdrawal of cheap finance and other liquidity measures could cause further contraction in lending in the short term as this is a major prop on asset prices along with QE and a subsequent devalaution.

    If the MPC raises rates, the overgeared may falter and the banks may need to fess up and take hits which balance sheets probably cant sustain even in nominal terms.

    Inflation is therefore the default option to clear the system, the banks continuing to distribute profits/dividends delays the removal of ’emergency measures’ .

    The regulators seem to be provided for well out of public funds. Some interesting pension fund info. No downside for missing targets?

    http://www.bankofengland.co.uk/publications/annualreport/2010/renumeration2010.pdf

    The MPC may find that controlling runaway inflation at a later stage has other consequences and may decimate the prudent as well as the profligate.

    http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/7909432/The-Death-of-Paper-Money.html

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    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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