inflation - Economics Help

UK Inflation Rate and Graphs

February 19, 2020February 19, 2020 by Tejvan Pettinger

Current UK Inflation Rate

CPI inflation rate: 1.8% (headline rate) CPI – D7G7 at ONS
(page updated 19 Feb 2020)

Source: Raw data General inflation tables | CPI annual % change D7G7 at ONS

Other measures of inflation

(CPIH) CPI including owner occupiers’ housing costs – 1.8% (CPIH – L550)
RPI – 2.7% (Jan 2020)
See: Measures of inflation

Cost-push inflationary factors

In 2017, the UK saw a rise in cost-push inflationary pressures. This caused a spike in inflation, despite relatively weak economic growth. Cost-push inflationary factors have come from:

Devaluation in Sterling. This makes imports more expensive and has fed through into higher input prices for manufacturers.
Rise in petrol prices in the early part of 2017.
Rise in food and recreational goods.

In 2018/19, these cost-push factors have fallen away and weak economic growth has kept inflation below target.

Reasons for low inflation in the UK

Low worldwide inflationary expectations. Europe is experiencing very low rates of inflation.
Fall in global inflation rates since 2007.
Supermarket price wars, with big chains, such as Tesco and Sainsbury attempting to maintain market share from Pound Shops and discounters like Lidl.
Weaker commodity price growth.
Fiscal austerity – many government departments still seeing spending squeezed. In particular public sector pay restraint of recent years has reduced real wages for public sector workers.
Private sector wage growth is still weak. This has limited costs of firms and limited growth in aggregate demand.
A potential negative output gap, with real GDP still around 10-15% below pre-crisis trend rate.

Inflation trends in the UK

Despite temporary cost-push inflationary factors in 2017, underlying inflationary pressures remain muted – at least compared to the past four decades.

The current UK inflation rate compares favourably to much of the post-war period.

1970s Inflation

The 1970s frequently saw double-digit inflation. This was due

Cost-push factors – rapid rise in oil prices
Rising wages due to powerful trade unions trying to keep up with living costs.
Lack of independent monetary policy
Inflation expectations rose

Late 1980s inflation

The inflation of the late 1980s was due to

Rapid economic growth ‘The Lawson Boom‘ – growth was above the trend rate causing supply shortages
Rise in house prices fuelling wealth effect
Lack of independent monetary policy. Policy was partly set by ‘shadowing the D-Mark’ which led to loose monetary policy in late 1980s

Inflation and wages

Real wages = nominal wages – inflation.
Usually, during a period of economic growth – wage growth is higher than inflation, this leads to positive real wage growth.
During the economic recession of 2009-13 – we had a prolonged period of negative real wage growth. Wages rising at a slower rate than inflation.
The end of 2014 saw the first signs of renewed wage growth and positive real wage growth.

In 2017/18, the trend of negative real wage growth resumed.

However, since 2018, wages have started to creep up whilst inflation has fallen.

See more at UK wage growth

Inflation since 1990

Inflation rose over 8% in the late 1980s due to the Lawson boom, which was a period of unsustainable economic growth.
Inflation was low in the period 1992 to 2007. This was a period known as the ‘great moderation’
The inflation of 2008 and 2012 was due to cost-push factors (devaluation and rising commodity prices)

Long-Term inflation forecasts

February 15, 2020February 14, 2020 by Tejvan Pettinger

Originally published in March 2015. Current inflation rate (Feb 2020) is 1.3%. I was 0.7% out.

But there was no skill in predicting inflation of 2%. If Ii had to predict inflation for 2025, I would predict the same = 2%.

Reader’s Question: What will be the inflation rate in 2020?

Firstly, I can’t resist a few economics ‘jokes’

“An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today. “
“The First Law of Economists: For every economist, there exists an equal and opposite economist.”
The Second Law of Economists: They’re both wrong.
Q:Why did God create economists ?
A: In order to make weather forecasters look good.

Funny Economics

To be honest, it is very difficult to make inflation forecasts for more than 12-18 months time. I feel that if you make inflation forecasts for 5 years in advance, you are really just guessing.

There are so many different scenarios which could happen in the next five years, which we can’t envisage at the moment.

uk-RPI-inflation-1948-2014

My Guess for inflation in 2020

After making a sufficiently long list of disclaimers, I’m happy to stick my neck out on the line and make the rather unexciting prediction that inflation will be 2%. (which happens to the government’s target for CPI inflation). The reason for this prediction is:

Generally, we have become quite good at keeping inflation low. The peak in inflation in 2010 to 5% is misleading, because it was just temporary cost-push inflation in the middle of a recession. Since the 1980s, we haven’t seen any significant demand-pull inflation.

Inflation is more likely to be low because:

The Bank of England was made independent in 1997. (Previously government set interest rates). Independent Central Banks are willing to take politically unpopular decisions to raise interest rates before an election reducing chance of boom and bust. Independent Central Banks are judged on their success in keeping inflation low, so they don’t want to lose their ‘low inflation credibility’.
Inflation expectations have fallen. It would take a big change in the economy (like the cost-push inflation of 1970s) to really shift inflation expectations upwards.
There is a strong will to reduce inflation. For example, Europe has tolerated very high levels of unemployment and prolonged economic stagnation – but they wouldn’t tolerate high inflation. I don’t see this changing, there is a very strong consensus on keeping inflation low amongst mainstream economists and politicians.
Continued improvements in technology and greater competitiveness of markets (e.g. see how competitive supermarkets have become in past few years.)

The greater concern is that we entering a period of disinflation – very low inflation, below the government’s target of 2%. Experience of the past few years and the experience of Japan suggests that these periods of very low inflation can be self-fulfilling and take a long time to get out of.

Long Range Inflation Forecasts may try to take these issues into account.

Are we entering a new era of macroeconomic stability, where central banks have finally mastered the art of managing the economy? The medium-term prospects for greater economic stability are quite promising in this regard. People are already suggesting that the boom and bust economic cycle are a thing of the past in the UK
Will a shortage of raw materials cause cost-push inflation? or will alternatives be found?
To what extent will new technology continue to lower costs?
Will global warming cause a shortage of food and water, therefore pushing up prices of basic necessities?
Will overpopulation cause demand to rise faster than supply

Problems of deflation

December 9, 2019December 9, 2019 by Tejvan Pettinger

Deflation is defined as a fall in the general price level. It is a negative rate of inflation. The problem with deflation is that often it can contribute to lower economic growth. This is because deflation increases the real value of debt – and therefore reducing the spending power of firms and consumers. Also, falling …

Inflation and Exchange Rates

December 24, 2019July 17, 2019 by Tejvan Pettinger

Readers Question: Why is it that the value of the exchange rate falls when there is higher inflation? How inflation affects the exchange rate A higher inflation rate in the UK compared to other countries will tend to reduce the value of the Pound Sterling because: High inflation in the UK means that UK goods …

Does inflation cause unemployment?

May 16, 2019May 16, 2019 by Tejvan Pettinger

Readers Question: Does inflation causes unemployment?

There are a few different scenarios where inflation can cause unemployment. However, there is not a direct link. Often we will notice a trade-off between inflation and unemployment – e.g. in a period of strong economic growth and falling unemployment; we see a rise in inflation – see Phillips Curve.

Also, it is important to bear in mind, (especially in the current climate) If the economy has deflation or very low inflation and the monetary authorities target a modest rate of inflation, then this may help boost growth and reduce unemployment.

Inflation can cause unemployment when:

The uncertainty of inflation leads to lower investment and lower economic growth in the long term.
Inflationary growth is unsustainable leading to a boom and bust economic cycle.
Inflation leads to a decline in competitiveness and lower export demand, causing unemployment in the export sector (especially in a fixed exchange rate).

Inflation creates uncertainty and lower investment

One argument is that a period of high and volatile inflation discourages firms from investing. Because inflation is high, firms are less certain investment will be profitable. It is argued that countries with higher inflation rates tend to have lower investment and therefore lower economic growth. Therefore, if there are poor levels of investment, this could lead to higher unemployment in the long term.

It is argued that countries with low inflation rates, such as Germany have enabled a long period of economic stability which helps to attain a long-term low unemployment rate. Low inflation in a country like Germany also helps them to become more competitive within the Eurozone, which also helps create employment and reduce unemployment.

Why do people mistrust official inflation statistics?

March 10, 2020April 22, 2018 by Tejvan Pettinger

In the UK and US there is often a mistrust of the government’s inflation figures. People often feel that their cost of living is rising faster than official CPI statistics. In developing countries like Venezuela and Argentina, there is even greater mistrust as government’s have an incentive to modify inflation rates and have the power …

Should low inflation be the primary objective of economic policy?

January 23, 2018December 11, 2017 by Tejvan Pettinger

The UK government has given the Bank of England an inflation target of CPI 2 % +/-1. The Bank of England is responsible for using monetary policy (e.g. interest rates) to achieve this goal of low inflation. But, as well as targeting inflation, the Bank of England also has a wider remit of considering objectives …

Disinflation – definition and meaning

January 16, 2018October 22, 2017 by Tejvan Pettinger

Definition of disinflation Disinflation is a fall in the inflation rate. It means that the general price level is increasing at a slower rate. When people talk of disinflation, they often mean a period of low inflation. For example, inflation falling below the inflation target of 2%. Between 2011 and 2015, there is a fall …

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