Stop worrying about inflation

It will go away but the danger of deflation remains.

It still looks a little early to me for the majority to swing and it would bring down a torrent of criticism on the Bank's head. But if not this week, then May, when the Bank will have the benefit of first-quarter GDP figures as well as other data, is beginning to look like a racing certainty.

A rate increase in May, when the Bank of England's Monetary Policy Committee produces its next inflation report, is looking like a given, says David Smith* in the above quote from his Sunday Times column (£).

For that to happen, there would have to be a major turnaround in the economy, which does not look likely, to say the least. The problem is that consumer and business confidence has collapsed, net trade is still negative, unemployment is rising, youth unemployment is on course to hit the million mark along with falling house prices and growth was negative in the fourth quarter.

I agree with Smith, though, that there will not be a rate increase this week.

With the economy in its current state, such a move would be a disaster and would likely have to be quickly reversed, perhaps even by the Chancellor with his powers under the Bank of England Act. Far from enhancing the MPC's inflation-fighting credibility, as the MPC members Martin Weale and Andrew Sentance have claimed, there is every possibility that such a move would be a death sentence for the MPC.

Keeping rates down as low as possible and hoping and praying and crossing all of his fingers and his toes that the MPC will do more quantative easing is Osborne's only plan B. A rate increase would mean he -- and probably the coalition -- would be finished. (May, by the way, is Sentance's last meeting and Osborne is unlikely to renew him or replace him with another hawk.)

The Bank of England governor, Mervyn King, has it right. The MPC needs to focus on the inflation that it is able to impact. Contrary to what Sentance has been foolishly claiming for months, inflation today or next week or in six months time is completely irrelevant for this week's MPC decision because it takes interest-rate adjustments about 18 months to feed their way through. The current inflation forecast of the MPC is overly optimistic and may well get revised down this month in light of the bad GDP numbers. Even with that forecast, inflation is well below target. Any rate increase would, in all likelihood, push the economy to deflation. The MPC's new inflation forecast, out next week, will show that inflation will be below target at the forecast horizon.

I have considerable sympathy with Professors Arestis and Sawyer, who argued, in a letter to the Financial Times last week, that the inflation we are experiencing has not been caused by excessive demand and that it would be nonsensical to reduce demand to "solve" it. They wrote: "It has long been recognised that, at best, interest rates by pushing down demand could address demand-push inflation and that they would be helpless in the face of cost-push inflation. At the present time, demand is still low in the UK and clearly significantly below capacity. The pressures on inflation are coming from higher world oil and food prices, value added tax and other tax increases and delayed effects of depreciated exchange rate. It is then clear that raising interest rates has no role to play in bringing down inflation." "No role" may be a bit strong but they make a good point.

I would go one step further and argue that the whole idea of targeting CPI inflation has failed. At the very least, the MPC's mandate should be extended to include growth and employment. The inflation measure should include house prices or could just simply be raised to 4 per cent. As I have said many times, happiness research shows that unemployment hurts people much more than inflation, especially now.

Inflation is going to collapse in 2012 when the impact of the one-off increase in VAT, oil and commodity prices and the exchange-rate depreciation mechanically drop out of the inflation calculations. As Mervyn noted in his recent speech, these three items alone account for 3 per cent of the current 3.7 per cent CPI inflation rate.

Inflation is going to go away because of the big output gap in the economy, simple as that. The danger of deflation, however, remains. Unemployment is rising and unless things improve quickly, any increase in rates would send the economy into a downward spiral as the effects of the VAT increase and spending cuts hit home. In all likelihood, Adam Posen is going to prevail and, by the summer, the MPC will be forced to do more QE. David Smith's racing certainty is likely to fall at the first fence.

*By the way, David, what ever happened to your building skip index? Presumably there aren't many around since the house price crash and the lack of availability of credit.

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

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After Richmond Park, Labour MPs are haunted by a familiar ghost

Labour MPs in big cities fear the Liberal Democrats, while in the north, they fear Ukip. 

The Liberal Democrats’ victory in Richmond Park has Conservatives nervous, and rightly so. Not only did Sarah Olney take the votes of soft Conservatives who backed a Remain vote on 23 June, she also benefited from tactical voting from Labour voters.

Although Richmond Park is the fifth most pro-Remain constituency won by a Conservative at the 2015 election, the more significant number – for the Liberal Democrats at least – is 15: that’s the number of Tory-held seats they could win if they reduced the Labour vote by the same amount they managed in Richmond Park.

The Tories have two Brexit headaches, electorally speaking. The first is the direct loss of voters who backed David Cameron in 2015 and a Remain vote in 2016 to the Liberal Democrats. The second is that Brexit appears to have made Liberal Democrat candidates palatable to Labour voters who backed the party as the anti-Conservative option in seats where Labour is generally weak from 1992 to 2010, but stayed at home or voted Labour in 2015.

Although local council by-elections are not as dramatic as parliamentary ones, they offer clues as to how national elections may play out, and it’s worth noting that Richmond Park wasn’t the only place where the Liberal Democrats saw a dramatic surge in the party’s fortunes. They also made a dramatic gain in Chichester, which voted to leave.

(That’s the other factor to remember in the “Leave/Remain” divide. In Liberal-Conservative battlegrounds where the majority of voters opted to leave, the third-placed Labour and Green vote tends to be heavily pro-Remain.)

But it’s not just Conservatives with the Liberal Democrats in second who have cause to be nervous.  Labour MPs outside of England's big cities have long been nervous that Ukip will do to them what the SNP did to their Scottish colleagues in 2015. That Ukip is now in second place in many seats that Labour once considered safe only adds to the sense of unease.

In a lot of seats, the closeness of Ukip is overstated. As one MP, who has the Conservatives in second place observed, “All that’s happened is you used to have five or six no-hopers, and all of that vote has gone to Ukip, so colleagues are nervous”. That’s true, to an extent. But it’s worth noting that the same thing could be said for the Liberal Democrats in Conservative seats in 1992. All they had done was to coagulate most of the “anyone but the Conservative” vote under their banner. In 1997, they took Conservative votes – and with it, picked up 28 formerly Tory seats.

Also nervous are the party’s London MPs, albeit for different reasons. They fear that Remain voters will desert them for the Liberal Democrats. (It’s worth noting that Catherine West, who sits for the most pro-Remain seat in the country, has already told constituents that she will vote against Article 50, as has David Lammy, another North London MP.)

A particular cause for alarm is that most of the party’s high command – Jeremy Corbyn, Emily Thornberry, Diane Abbott, and Keir Starmer – all sit for seats that were heavily pro-Remain. Thornberry, in particular, has the particularly dangerous combination of a seat that voted Remain in June but has flirted with the Liberal Democrats in the past, with the shadow foreign secretary finishing just 484 votes ahead of Bridget Fox, the Liberal Democrat candidate, in 2005.

Are they right to be worried? That the referendum allowed the Liberal Democrats to reconfigure the politics of Richmond Park adds credence to a YouGov poll that showed a pro-Brexit Labour party finishing third behind a pro-second referendum Liberal Democrat party, should Labour go into the next election backing Brexit and the Liberal Democrats opt to oppose it.

The difficulty for Labour is the calculation for the Liberal Democrats is easy. They are an unabashedly pro-European party, from their activists to their MPs, and the 22 per cent of voters who back a referendum re-run are a significantly larger group than the eight per cent of the vote that Nick Clegg’s Liberal Democrats got in 2015.

The calculus is more fraught for Labour. In terms of the straight Conservative battle, their best hope is to put the referendum question to bed and focus on issues which don’t divide their coalition in two, as immigration does. But for separate reasons, neither Ukip nor the Liberal Democrats will be keen to let them.

At every point, the referendum question poses difficulties for Labour. Even when neither Ukip nor the Liberal Democrats take seats from them directly, they can hurt them badly, allowing the Conservatives to come through the middle.

The big problem is that the stance that makes sense in terms of maintaining party unity is to try to run on a ticket of moving past the referendum and focussing on the party’s core issues of social justice, better public services and redistribution.

But the trouble with that approach is that it’s alarmingly similar to the one favoured by Kezia Dugdale and Scottish Labour in 2016, who tried to make the election about public services, not the constitution. They came third, behind a Conservative party that ran on an explicitly pro-Union platform. The possibility of an English sequel should not be ruled out.  

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to British politics.