Should Labour adopt the four per cent inflation policy?

Controversial ideas of the past are becoming consensus of the present.

A 1998 proposal by Paul Krugman that the western world should target inflation at four per cent rather than two per cent, has got the backing of the IMF (pdf). The intention would be to erode government debt, and to give policy makers a more flexible tool in the future, rather than resorting to quantitative easing (QE).

In our battle to combat inflation, we fought for it to be as close to zero as it can be without grinding growth out. Two per cent seemed to be that point. However, now that we’ve got that control, we don’t have to keep it so low.

In 2007, if inflation had been at four per cent instead of two per cent, then interest rates would have been seven per cent rather than five per cent, and the Bank of England would have had more room to cut when crisis struck. In other words, they wouldn’t have needed to go beyond zero to engage QE.

Some people might say that since we’ve finally beaten inflation, it’s not wise to bring it back? But it’s not inflation that causes problems, it’s unpredictable inflation that we fear. If we had a high rate of say 10 per cent, but steady, year in year out, then companies and people would be able to plan around it. But if we didn’t know whether inflation will be 5 per cent or 15 per cent, then how much should a bank charge for a loan? Can a company calculate the profit they’ll make, if they don’t know how much the money will be worth. So four per cent is fine, as long as it’s steady.

The other benefit of running a higher inflation rate is that we would erode our debt much faster. If the interest on a gilt is four per cent, then two per cent inflation would cancel it out. If your mortgage were two per cent, then four per cent inflation would leave you with a negative real interest rate of minus two per cent.

Krugman accepts that this would be rewarding debtors for their past excesses, but argues that “economics is not a morality play.” Is he right to dismiss morality so easily? Surely modern day politicians make their living from telling bankers they are not good citizens. Is it appropriate to dismiss investors with the refrain of caveat emptor, buyer beware?

It’s worth remembering that no investor complained when QE was buying up that same debt for higher than it’s real value. Besides, if investors had feared inflation, they could have bought index linked gilts. These track inflation and rise in value proportionately. They make up only about 10 per cent of gilts. So when it comes to the other 90 per cent, I contend that ethical arguments are insufficient to reject the policy.

The big question is whether policy could easily switch inflation from two to four. Much of the cause of inflation is expectation. In the '70s, inflation was high because trade unions made demands for wage rises on the expected future inflation rate. These rises then caused inflation to rise to the same level, and unions would demand a rise again. It was self-perpetuating.

Conversely, when Gordon Brown made the Bank of England independent, inflation markedly dropped off and stayed low. This wasn’t due to a policy of the bank, but due to the confidence inspired by it’s independence.

Should a policy of increased inflation be kept a secret? My experience of politics is that if you have something controversial to say, then be confident, say it forcefully, then stick around to face down your critics. The public aren’t experts on economics. They will make judgements on the confidence of the advocate and the reaction of pundits.

On the question of whether the markets will react badly to such a policy, I think that depends on the timing. Right now, with no demand in the economy, the market wouldn’t react badly because they have nowhere else to go. These days most savers keep their money on deposit with an interest rate lower than inflation. They are losing money in preference to the uncertainty elsewhere.

There are few safe havens in today’s investment world, partly due to the bad policy imposed by politicians such as David Cameron and Angela Merkel. When considering our economic policy for a future government, we must recognise that controversial ideas of the past are becoming consensus of the present, and deserve our serious consideration as policy for the future.

The Bank of England. Photograph: Getty Images

Dan McCurry  is a photographer in east London and a Labour activist. He is a former chair of the Bow Labour Party.

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PMQs review: Jeremy Corbyn bids for the NHS to rescue Labour

Ahead of tomorrow's by-elections, Corbyn damned Theresa May for putting the service in a "state of emergency".

Whenever Labour leaders are in trouble, they seek political refuge in the NHS. Jeremy Corbyn, whose party faces potential defeat in tomorrow’s Copeland and Stoke by-elections, upheld this iron law today. In the case of the former, Labour has already warned that “babies will die” as a result of the downgrading of the hospital. It is crude but it may yet prove effective (it worked for No to AV, after all).

In the chamber, Corbyn assailed May for cutting the number of hospital beds, worsening waiting times, under-funding social care and abolishing nursing bursaries. The Labour leader rose to a crescendo, damning the Prime Minister for putting the service in a “a state of emergency”. But his scattergun attack was too unfocused to much trouble May.

The Prime Minister came armed with attack lines, brandishing a quote from former health secretary Andy Burnham on cutting hospital beds and reminding Corbyn that Labour promised to spend less on the NHS at the last election (only Nixon can go to China). May was able to boast that the Tories were providing “more money” for the service (this is not, of course, the same as “enough”). Just as Corbyn echoed his predecessors, so the Prime Minister sounded like David Cameron circa 2013, declaring that she would not “take lessons” from the party that presided over the Mid-Staffs scandal and warning that Labour would “borrow and bankrupt” the economy.

It was a dubious charge from the party that has racked up ever-higher debt but a reliably potent one. Labour, however, will be satisfied that May was more comfortable debating the economy or attacking the Brown government, than she was defending the state of the NHS. In Copeland and Stoke, where Corbyn’s party has held power since 1935 and 1950, Labour must hope that the electorate are as respectful of tradition as its leader.

George Eaton is political editor of the New Statesman.