Tuesday, 20 April 2010

For richer, for poorer

Today's news from the Office for National Statistics is that inflation in March had risen to 3.4%.

The Governor of the Bank of England, Mervyn King, has said that he expects this rise and that other pressures will bring the inflation rate down in time. This analysis seems more than cautiously optimistic but Mr King does not want to contribute to the looming possibility of stagflation by appearing to predict runaway inflation. His prediction is beginning to sound unrealistic because inflation tends to create its own spiralling effect and, now that we have a significant upward trend, the likeliest outcome is that inflation will drive itself higher. Many wage settlements will automatically reflect the increase in the Consumer Prices Index and retailers and manufacturers who are paying more for stock and materials do not have the margins to allow them to hold prices in check. The combination of price inflation with low interest rates may cause sterling to fall even lower. That, in turn, will mean that imports, particularly oil, will be more expensive and prices will rise still further.

The British, however, have always considered rising prices to be a good thing. We call it the "property ladder" and we are delighted when house prices seem to be going up and equally miserable when they seem to be falling. There is some justification for this. The "profits" we make on the increased value of our homes may be an illusion because we are destined to exchange each property for another that is equally over-priced but, as inflation marches onwards, we find that the real value of the mortgage that finances our home ownership diminishes year on year. If the whole process goes into reverse then thousands of people in the UK rapidly descend into "negative equity" because their mortage represents such a high proprtion of the puchase price of their house. So, in practice, inflation makes us richer. No wonder Mervyn King is content to allow prices to rise.

Yet that isn't the whole story. A few people in Britain have savings. They ought to be very unhappy to find that, even if they spend none of the interest on their accounts, their savings are rapidly losing value. There are also some poor souls whose wages are not rising with inflation. They, along with those living on savings, are rapidly getting poorer.

So, ironically, the national economic medicine that we are swallowing at the moment is rewarding anyone who has borrowed a great deal or is guaranteed a pay increase, regardless of performance, that corresponds to inflation but punishing all other workers and savers. It may be that there is no alternative to the Bank of England's monetary policy right now but are we really ready to lay the foundations of a sound economy for the future?

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