Inflation was an issue in 1921

With inflation threatening to rise to 6 per cent, there was a cost of living crisis 100 years ago.

The Leamington Spa Courier was preoccupied with the cost of living crisis and high prices in Leamington at the end of October 1921.  ‘It is generally agreed that in Leamington, as elsewhere, the housewife is being charged far too much for meat and other articles of food, and the time has arrived when a substantial drop will have to be made.  People simply cannot afford to pay, and it is a question as to how much longer they will be able to hold out.’

‘That butchers are demanding prices of the average housewife which, when compared with the wholesale charges, are unwarranted, was illustrated at the meeting of the Warwick Joint Hospital Board on Wednesday, when it was reported that good quality was being supplied to the Heathcote Hospital at 1s 6d a lb.  (£3.75 in 2020 prices).  The housewife would be glad to receive similar treatment. It may be argued by the butcher that public institutions get a preference owing to their requiring large quantities, but this cannot apply to Heathcote where there are six patients – the size of an average family. 

It is clear that some butchers are not as desirous of grabbing the last penny as others, and there are shops in Leamington where meat can be had at fairly reasonable prices.  The housewife is advised to seek them out.   Enquiry will soon show, and it it worthwhile – if indeed it is not a public duty to do so.  Bring the butchers into closer competition.   Where prices are obviously too high, why not transfer custom elsewhere?’

The Mayor, Councillor England, intervened in the debate: ‘I feel very strongly so long as the prices of foodstuffs are kept up we cannot expect a drop in the standard of wages, and until we get a fall in wages, we shall continue to have unemployment.’    [1921 saw a severe post-war recession and unemployment was at 11.3 per cent.  After rising by over 15 per cent in 1920, inflation fell in 1921].

‘Mr Leonard Lees of the Master Butcher’s Association was cynical when we told him this morning that the farmers might conceivably help consumers in the fight against high prices by arranging a direct supply.  “They would find there is not so much in it after all,” he said.  “The butchers lost money after control went off, and we had a shocking time for six months.”   The farmer’s point of view is quite reasonable, however, and as a consumer he naturally expects retail prices to bear some relation to what he gets for his cattle in the market.’

‘The failure of retail prices to move in line with producers’ prices costs the consumers 2.25d per lb on his beef, 5d per pound on his mutton, and 2.5d on his loaf.  Or, put in another way, had the consumer benefitted to that extent, the Ministry of Labour cost of living index on October 1^st, instead of being 110 per cent, would have only been 103 per cent above the 1914 level.  At Banbury the fight has had beneficial results.  Yesterday well-fed English mutton was sold at 8d a lb (£1.65 in 2020 prices) and the vendor’s stall was cleared in an hour.   

The reduction in the price of bread in Leamington has come to pass, so that the quarter loaf now cost 11.5d over the counter and one shilling if delivered.  (£2.50 at 2020 prices).   The Birmingham and District Master Bakers’ Association last night decided to reduce the price to 11d at the counter from Monday.  Why cannot Leamington bakers follow suit?

[From the Leamington v. Kettering programme]

Black hole in public finances

Ministers have been sounding a gloomy tone recently and it's not just because of the eurozone crisis. Work by the Financial Times using the Office for Budget Responsibility model suggests that the structural deficit is £12bn higher than previously thought, a slippage of 25 per cent.

It seems that the level of spare capacity in the economy, both in terms of plant and labour (with the right skills mix), is lower than was previously thought. I would add a note of caution here as spare capacity is more difficult to forecast than most economic variables.

What this would imply is yet more spending cuts or tax increases, but politically that is not viable given the sluggish growth in the economy which, according to the Bank of England, would have tipped into recession but for quantitative easing. What the Bank also admits that QE has pushed inflation higher than it would have been by 0.75 to 1.5 per cent. Of course, inflation also reduces the real value of the debt.

In any event we aren't going to see value added tax go up to 22.5 per cent which is what would be required to plug the gap. But it is does show how difficult will be for the Government to meet its structural deficit target and have some good economic news by the time of the next general election.

Walking the tightrope

Both the Government and the Bank of England are walking a tightrope in terms of economic policy at the present time. The Bank is (quite properly) a relatively secretive institution, even if much more transparent than it was in the past and I am not claiming to have any special inside knowledge.

However, there are concerns by observers of the Old Lady that inflation has got baked into the cake. Electricity prices are expected to go up by 10 per cent in the summer and gas prices by 15 per cent, the latter driven by liquified natural gas demand from Japan.

It could be argued that increasing interest rates would actually do very little to drive down inflation and would impact on consumers by pushing up mortgage rates. The Bank does consider, however, that inflation will eventually diminish because there will be no further VAT rise; no further fall in sterling; and (hopefully) no big rise in energy prices.

Exports have been largely driven by sterling depreciation. It is particularly a matter of concern that imports by businesses resoponding to Bank surveys have not been affected at all despite a 20 per cent rise in their cost. Imports are predominantly intermediate ones suggesting that no domestic substitution is occurring. However, it is possible that the rate of growth in imports may have been slowed down.

The consequences of an unprecedented fiscal contraction in the UK economy have yet to be seen. However, big corporates do have tons of cash they could spend. Employment intentions are picking up, but a lot of it is part-time and self-employed.

There have been substantial differences on the Monetary Policy Committee (MPC), although these will diminish with the departure of ultra inflation hawk Andrew Sentance who even seemed to question the Bank's forecasts. Sentance's argument is in essence that it is really all about global imbalances rather than UK domestic conditions and the former will persist.

More generally, the differences on the MPC reflect considerable uncertainty about risks. Some members of the MPC are concerned about the credibility gap in terms of constant overshooting of the inflation target. People are arguably more concerned about growth and employment than inflation.

At the moment there is an unprecedented monetary expansion and at some point this will have to stop. However, there is believed to be some concern in Bank circles about the fragility of the economy and downside risks.

The Bank has in effect admitted that the output gap (slack in the economy) is smaller than thought and this means that any expansion may see limited productivity gains and create inflationary pressures. It is unfortunate that the output gap is one area in which data is less reliable, but it is evident that some physical capacity has been destroyed for ever. There are also some signs of skill shortages appearing, especially in engineering.

One uncertainty is the sterling exchange rate. Bank thinking is to prefer the current rate, but a mild appreciation seems likely. In any event it cannot be managed.

Growth has been driven by larger firms, but business has never been better at the company owned by one of my children and her husband. New workers have been taken on and the order book is full. However, they were not receptive to the idea of a chat with the Bank's regional agent.

The economic outlook

The Magna Carta institute at Brunel University run by Justin Fisher held an interesting event on 'The Coalition - one year on' at the British Academy earlier this week. I plan to talk about some of the other presentations later, but here is a summary of what I had to say (my statistics generally come from the National Institute for Economic and Social Research).

The 'privatised Keynesianism' model identified by Colin Crouch in which the economy is driven by consumer debt linked to the housing market is no longer viable in the medium term, if at all. Consumer spending is forecast to fall by 0.6 per cent in 2011 (it still accounts for two-thirds of aggregate demand).

Consumers are being squeezed by inflation at 4.5 per cent with real disposable incomes falling. Indeed, I think that the Bank of England has de facto abandoned the inflation target. That may not be a bad thing, but they won't admit it is what they have done. Given fiscal consolidation, the economy needs a monetary stimulus and inflation also erodes the debt burden.

Real house prices are forecast to fall by 4.5 per cent in 2011, although the London market is still relatively buoyant, especially at the higher end where it is driven by foreign buyers. There is a fear of unemployment, particularly in the public sector. The Government's austerity rhetoric may have dented consumer confidence.

Export led manufacturing growth is forecast to be 6.9 per cent this year and 4.3 per cent in 2012. This is mainly driven by the weakness of the pound. All three political parties support rebalancing the economy and this is one of Nick Clegg's little known strategic objectives. However, much of manufacuturing is now essentially assembly operations and much of the value chain in industry has been wiped out. It should be noted that past government industrial policy interventions have not been conspicuoulsy successful.

The OBR's growth forecast for 2011 is now seen as rather optimistic and many commentators anticipate 1 to 1.5 per cent. It is unlikely that the economy will grow faster than the trend rate of 2.1 per cent until 2013. The higher growth rates recorded recently have little to do with government policy but reflect the fact that they have been hit less hard by the banking crisis (so far, but they are exposed to a Greek default). The German economy also has strength in high quality, high valued added manufacturing.

The output gap is probably larger than we thought whuich means that the sustainable output of the economy is lower than thought. Productivity growth is likely to be low and the economy will not grow as fast as it did without generating inflation.

It should be noted that the Coalition Government does not aim to eliminate the cyclical deficit (the cyclically-adjusted current budget) so in fact Conservative and Labour positions on the budget are less far apart than the rhetoric would suggest. There will be public spending increases in real terms over the Parliament, although as a share of GDP public expenditure will fall back to 40-41 per cent.

Given that the weakness of the recovery will depress tax revenue, even if (a big if) spending targets are met, net borrowing will fall to 3.6 per cent of GDP in 2015-16 rather than the projected 1.5 per cent. The current budget will run a deficit of 2.2 per cent of GDP compared with the 0.2 per cent forecast.

The Government has been criticised for the lack of a growth strategy, but there are limits to what governments can do to stimulate growth. The most useful measures such as skill formation only bear fruit in the medium term.

Inflation

The slowing in the inflation rate was unexpected and good news. It means that the pressure is off the Bank of England to raise interest rates for now. Given that most households now have variable interest rate mortgages this will at least delay a further squeeze on household incomes.

What seems to have happened is that consumer resistance to higher prices persuaded retailers to reduce some prices. However, other cost pressures remain. The oil price goes relentlessly upwards. A 10-15 per cent in electricity and gas prices is likely in early summer.

Also most consumers don't perceive that inflation is not rising so quickly. This is not surprising when the cost of so many items is still going up. However, against the background of high unemployment this may not translate into significant upward pressure on wages.

A note of caution

A welcome note of caution here about reading too much into one quarter's GDP figures, particularly when they have been distorted by bad weather: GDP

This article rightly stresses concern about inflation, although talk of stagflation in the City is a bit overdone, particularly for those of us who remember annual rates of 25%+ in the 1970s.

The pound dipped against the dollar after the figures came out because of fears that interest rate rises would be delayed, which seems likely, although two members voted for a rise at the last MPC meeting.

If the Government abandoned its austerity package, sterling would fall and inflation, which is being driven largely by world commodity price increases, would go even higher.

Inflation rate

There are some useful historical figures on inflation here: Inflation

Talking of a 'whopping' 3.7 per cent inflation rise seems a bit over the top when some of us experienced annual rises of over 25 per cent. But part of the problem at the moment is that public sector salaries are frozen and they are not going up that much in the private sector.

It's also worth noting that the inflation rate looks much lower when one excludes indirect taxation. In November the CPI was 3.3 per cent, but the CPIY rate, i.e., excluding indirect taxes was 1.6 per cent, under half as much.

From government's point of view some inflation is not a bad thing as it erodes the mountain of public debt.

The rising misery index

The misery index in the economy is likely to rise next year. Unemployment is almost certain to go up, although there is some dispute about how much it will increase by. However, it is unlikely that all the lost public sector jobs can be replaced in the private sector. Indeed, private sector bosses may be unwilling to hire displaced public sector workers whom they suspect of having led a cushy life. Women will be particularly affected as they are disproportionately employed in the public sector.

Inflation shows no signs of easing. There is pressure on commodity prices, particularly food, gas, oil and cotton. At some point the Bank of England will start to increase interest rates, although by how much and when remains a matter of argument. The CBI says 2.5% by year end: I think 1.75% is more likely.

Even so, one of the things that has helped many people through the recession is that mortgage interest repayments have, depending on the deal a person has, have been kept low. If they rose, real disposable income would be reduced even further. As it is, it will be hit by fact that wages are not generally keeping pace with inflation, by the rise in VAT and by the 1p per £ increase in national insurance contributions from April which is in effect a 1 per cent rise in income tax.

Not surprisingly, retailers are worried about consumer demand. Of course, an objective of current policy is to shift the economy from one driven by private consumption to one in which exports play a greater role.

Meanwhile, the Government is suffering a series of defeats at the hands of fiscal nimbyism. The unfortunate Michael Gove has had to retreat on school sports and free books for young children. In the latter case the sum involved is small, but one way in which retrenchment tends to happen is by cutting smaller programmes completely. Now the Government is under pressure on the forensic science service, the privatisation of which strikes me as not a good idea.

Campaigns may achieve victories on particular issues. An alliance of nimbys may well defeat the proposed HST from London to Birmingham, the start of a larger network. My local MP Chris White has come out against it, reflecting the views of his constituents. The opponents of the scheme say that the business and environmental case is flawed, but if that is so, how have countries such as China, France, Japan, Korea and Spain been able to make high speed trains viable whereas we just have a stretch of line in Kent?

What is clear is that there is choppy political water ahead in 2011 and it may not be possible to deflect the opprobium on to the Liberal Democrats.

The era of cheap undies is over

So proclaimed The Sun this morning and they are right. Cotton prices have gone up by 45 per cent and this is likely to feed into a price rise of 5 to 8 per cent in the shops next year according to Next.

The latest CPI figures show inflation at a stubborn 3.1 per cent, down from its April peak, but well above the Bank of England 2 per cent target. Food prices in particular have risen, as well as clothes. With supply and demand pressures on food staples, some are predicting a double digit rise in food prices by the end of the year.

This has a number of implications for government policy. There is likely to be more resistance to a public sector pay freeze if real incomes are being eroded by inflation, particularly on basic items like food and clothes. It would also affect the cost of providing the state pension.