Today the Monetary Policy Committee of the Bank should seek to answer why and how inflation has taken such a hold over the last year. It’s not just a case a few rogue items, or the result of the hike in VAT. Food, alcohol and tobacco, transport and education within the CPI are all likely to be going up by more than 5% a year. Within those categories there will be much sharper rises in items like fruit, oils and fats, car running costs, fuel, fares and drinks. Even clothing is now increasing rapidly, thanks to cotton and other raw material increases.
It’s not as if it was difficult to forsee. This site has been warning about likely inflation for longer than a year. If the Bank allows inflation to stay too high for too long it will squeeze our spending power too much. It also transfers more money from savers to borrowers.
The Bank needs to remember that it is RPI inflation which has a bigger influence on contracts, wages and index linked payments throughout our system. The RPI has consistently been running more than 1% faster than the CPI which the Bank targets. People now expect more inflation than the Bank forecast. They have become sceptical of the Bank’s grip on this important matter. Part of this arises from the different methods of calculation, but many think the RPI is closer to their own experience of price rises.
The way out of a crisis brought on by the past government’s policy of encouraging all areas of our economy to live life beyond our means is to encourage saving and reward it, and to encourage paying down debt. Instead the Bank’s policy has rewarded the heavy borrowers with low interest rates, rewarded the banks who overlent with low interest rates on the money they need, and penalised the savers and depositors with those same banks. The savers, more numerous than the borrowers have not only taken a hit through low savings rates, but have also faced a series of tax increases as well.
I argued for lower interest rates in 2008 to stave off the banking crisis we were put through. Then they were urgently needed to avoid immediate disaster. The Bank delayed them for too long with predictably bad results. Once the banks were stabilised higher rates were needed to restore some balance between savers and borrowers. The structure of interest rates which has emerged is anyway very different from the Bank’s wishes. They have set 0.5% as their short term rate for the government and the banks, but the private sector faces rates of 5-8% to borrow on mortgage or small business loan.
There are those on the MPC who point out that wages are not going up very quickly overall, and in some cases not at all. They keep telling us there is no inflation out there. They point out that money growth remains weak. The problem with this view is that it ignores the fact that prices are going up too quickly and have been for some time. They seem to think the UK lives in its own vacuum. There is a very nasty inflation around the world. It is obvious in the uncomfortable surge in food prices, the big rises in most commodity prices, the dearer fuel, food and transport which we can all see. Low interest rates weakened the pound which increased its impact on UK consumers. We are experiencing the results of easy money in the US, China and India, as well as the results of our own domestic Central Bank policy.
How the method of calculation makes the RPI often go up faster
The government provides an example of how the method may produce a higher figure from the same items. The sum assumes a two item CPI or RPI to make the illustration easier. If one item in the CPI goes up 25% and one falls by 20% , inflation is zero. The Index multiplies the figures out and takes the square root (for two items). If the same happens in the RPI inflation is 2.5% as you add the two sub indices and average them arithmetically.