Sunday, 17 February 2008

Stagflation is back

Not only is public ownership back on the agenda, but we are now threatened with the return of stagflation: low growth and inflation. It does look like a return to the 1970's show.

I have noticed everyday items going up in price much more recently than for a very long time, e.g., the cost of a haircut (although with its high labour content that is always going up), fish and chips and delivery charges by my newsagent. Of course, big ticket items like second hand cars are going down so the overall inflation rate is lower than it appears to be.

But consumer psychology is such that the small ticket items are the ones that tend to stick in their minds - along with higher petrol prices and utility bills. One consequence is that people may lose confidence in the credibility of the inflation rate, already eroded by the divergence being the Government's favoured CPI measure and the higher rate of RPI.

No less a figure than the Governor of the Bank of England, Mervyn King, has warned Britons that they must face up to a 'genuine reduction in our standard of living.' This statement accompanied his presentation of the most pessimistic forecasts for growth and inflation since the Bank gained operational independence in setting interest rates 10 years ago. However, I think the real reason for his gloom was to warn that we cannot offset prices increases by demanding higher wages.

The problem is that cutting interest rates does not do anything about higher food or utility prices which are driven by global economic conditions. Nor does it translate readily into a reduction in mortgage rates, given the wish of lenders to improve their margins and the continuing shortage of liquidity.

In conditions of relatively full employment, many workers are in a strong bargaining position to seek higher wages. Retail demand still seems to be relatively buoyant and the Bank may well have taken a risk on inflation. However, it is doubtful if it would have acted as it has done without the context of the financial crisis.

Hang on to your seats for a rocky ride, economically and politically!

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