Is low inflation a good thing?

Today it was announced that the CPI measure of inflation had fallen to 1%, a 12 tear low and also well below the Bank of England’s 2% target. Lib Dem dogsbody Danny Alexander welcomed the news, saying “This is a welcome early Christmas present to millions of families across the country.” Thanks Santa! The thinking in Government seems to be the lower the better, because they are desperate to negate Labour’s ‘cost of living crisis’ attack, but is low inflation really a good thing? Helpfully, FT columnist Tim Harford wrote a short piece on this in February, some of which I will reproduce here:

“What wrong with low inflation?

Nothing, so far – but you can have too much of a good thing. Inflation is also low and edging downwards in the US, Japan and the eurozone. Yet in all these places, interest rates are low and central bankers have printed enough money to get the tinfoil hat brigade screaming about hyperinflation. Such low inflation might be an indication of trouble ahead.

Are you saying that low inflation is a bad thing, or are you saying that low inflation is merely a harbinger of doom?

A bit of both – but mostly I am concerned that low inflation is a bad thing in itself. One issue is that unexpectedly low inflation redistributes from borrowers to creditors.

About time too, most savers will be thinking.

I hear you. Still, borrowers are more likely to be cash-constrained (that’s why they are borrowers) and are more at risk of bankruptcy. That means lower-than-expected inflation may damage the economy as a whole rather than just moving money from one person’s pocket to another’s. And there’s another problem with deflation: the “lower-bound” problem.

What’s that?

It’s a fancy way of saying that nominal interest rates can’t fall below zero. If inflation is, say, 4 per cent then a central bank can give an economy a shot of adrenalin by cutting interest rates after inflation to minus 3 or minus 4 per cent. If inflation is 0.7 per cent – as it’s currently estimated to be in the eurozone – then that’s impossible.

Why would anyone want real interest rates of minus 4 per cent?

Usually we wouldn’t. But, against the backdrop of a slack economy, such rates would be a strong incentive to spend. And if outright deflation took hold, effective interest rates would rise: people would earn money simply by sitting on their cash and waiting for prices to fall. Sounds great but for an economy it’s a disaster. If nobody buys anything there will be a recession and more deflation – a vicious spiral.

But that isn’t going to happen. Is it?

Don’t ask me, I’m an economist. We never know what’s going to happen to the economy. But it is a serious enough problem that even a low risk is worth losing sleep over.”

I guess the key points are that low inflation harms borrowers in that it raises the real interest rate on existing debt, and if it continues to fall and we get into deflation territory, consumers start postponing spending, believing prices will fall further in the future. This could push us back into recession. So much as the likes of Danny Alexander may celebrate falling inflation, let’s hope it’s not a precursor to some pretty nasty economic problems to come.

What is Full Employment?

George Osborne gave a speech today in which he gave a commitment to achieving ‘full employment’. The trouble is, full employment means different things to different people. Osborne seems to think it means having the highest employment rate in the G7. We’re already 4th on that measure (which is I guess why he chose it), but is this a good measure? It looks at the proportion who are employed, but to know if we have ‘full employment’, don’t we need to know how many are ‘unemployed’?

Chris Giles already has a blog up today with the same name as this one, and he gives two other definitions to the one George Osborne is using. Post-war, full employment just meant everyone had a job who wanted one. For most of the 50s and 60s, this was indeed the case. As Robert Skidelsky says here:

“Between 1950 and 1973 unemployment averaged 2% and was always well under one million.”

2%! We’re supposed to be happy with 7% today. Of course at that time there were much fewer women in the workplace, but they weren’t classed as unemployed because more households could get by on one income back then.

The second definition Giles gives  I suppose you could say is the economist’s definition. That is called the NAIRU or the “non-accelerating inflation rate of unemployment” to give it its full name. Many (most even) economists believe that there is a trade-off between inflation and unemployment and that once unemployment falls below a certain level, inflation will start to accelerate. Ex Tory Chancellor Norman Lamont once said that unemployment was a price well worth paying to ensure inflation stayed low. The NAIRU in the UK is estimated at anywhere between 5 and 7%. This Guardian story gives a bit more detail:

“The Bank of England and the Office for Budget Responsibility (OBR) suggest that once the “equilibrium rate” for unemployment is reached, then full employment is achieved. The OBR said in its fiscal and outlook forecast, published at the same time of the budget, that unemployment would fall to its equilibrium rate in 2018.

The equilibrium rate is not fixed. In its February 2014 inflation report, the Bank of England said that the medium-term equilibrium unemployment rate was 6 to 6.5%, which means that unemployment remains 0.75 to 1.25% above this. The OBR said it judged that the long-term unemployment rate was 5.25% – with unemployment 1.75% above that. The bank says that the medium-term equilibrium unemployment rate will fall as demand recovers.”

So where does that leave use then? Full employment is either “the highest employment rate in the G7”, some technical, estimated rate believed to be the low-point at which inflation remains stable, or some loose (but much higher in some respects) definition of “everyone who wants a job has one”. I prefer the latter, but we could even extend this further and define it as “everyone who wants a job has one at a wage high enough to have a decent standard of living”. Wouldn’t that be something worthy of the name “full employment”?

I suspect George Osborne thinks he can get to his version of full employment by doing basically what he’s been doing, a bit of hand-waving while relying on the private sector to pick up with the help of rising levels of household debt. Which will be fine. Until it isn’t. Genuine full employment requires a much more active government than any of the main parties are currently willing to entertain. Here’s some further reading on how we could really get there.



Inflation, corporate welfare and another UKIP SOH failure

A lot of links to get through this week. First up, here’s a post outlining how we might overhaul the tax system to make it more progressive:

Towards a truly progressive tax system

And here’s two posts on inflation. Inflation is low and falling at the moment. Policy makers are so scared of inflation, they avoid policies that might improve the economy:

The Inflation Obsession

What causes hyper-inflation? Weimar Republic, Zimbabwe, Argentina, Venezuela

Next, George Monbiot reminds us that while the Government is obsessed with cutting welfare from those at the bottom, corporate welfare is still alive and well:

The welfare dependents the government loves? Rich landowners | George Monbiot

And here, JD Alt points out the obvious – if the private sector can’t or won’t invest in areas that are vital for future development, then the government should:

Forget the 1%

There was a Panorama this week about food poverty. Patrick Butler gives us the details:

Food poverty: Panorama, Edwina Currie and the missing ministers

‘Making work pay’ is a cliche we hear a lot, but according to this blog post, work already does pay in the vast majority of cases:

Yes, you’re better off working than on benefits – but it’s not enough to reduce poverty

With unemployment still high (athough falling) and the Work Programme failing, Labour say they will introduce a ‘compulsory jobs guarantee’. Details on what this will look like have been vague, but they are now hinting it might look something like this:

Labour would bankroll ‘back to work’ plan on Bradford model

Finally, news of another massive sense of humour failure from UKIP. Tom Pride explains:

Supposedly pro-free speech UKIP tries to ban satirical comedy show