As 2019 begins, we face countless economic problems: uncertainty about Brexit; stagnant productivity; the demise of the high street; a moribund housing market; and a global trade war, among other things. In this context, it’s worth noting that one thing is not a problem – inflation.
Figures next week are likely to show that CPI inflation has fallen to 2.2 per cent. This should remind us that it has been reasonably stable for years. In the last 25 years it has averaged 2 per cent, with a standard deviation of just one percentage point. And many of those deviations have been short-lived ones caused by variations in sterling or oil prices.
If you looked only at the data, you’d infer that there is a natural rate of inflation rather than a natural rate of interest or of unemployment.
For those of us formed in the 1970s and 1980s, this is a remarkable development. Back then high and variable inflation was a major source of uncertainty and instability. And the question of how to control it dominated politics. Today, we no longer have to think about such matters. And given that we are bad at thinking, this constitutes great progress.
A big reason for this is that expectations are self-fulfilling. If companies expect inflation to be low, they’ll not raise prices much and so it will be low. And workers who expect low inflation won’t push for pay rises, thus reducing the need for big price rises. What’s debatable, however, is how far this is the result of economic policy – the decision to target inflation rather than exchange rates or the money stock – and how far due to emergent global forces making for stable inflation.
This does not mean we can forget inflation entirely. Even stable 2 per cent inflation will cause the value of our money to half over 35 years. That matters for people planning their retirement.
Nevertheless, this stability is something for which earlier generations of economists yearned. They thought that if bosses didn’t face so much uncertainty about future prices they could plan their businesses better. “Our economic system will work best when producers and consumers, employers and employees, can proceed with full confidence that the average level of prices will behave in a known way in the future,” said Milton Friedman in his famous address to the American Economic Association in 1968. This, he thought, would create a climate “favourable to the effective operation of those basic forces of enterprise, ingenuity, invention, hard work, and thrift that are the true springs of economic growth”.
Herein, though, lies a problem. Years of stable inflation have not made these forces any stronger. In fact, productivity and GDP have grown more slowly in recent years than they did in the 1970s and 1980s. The lesson here is important and under-estimated – that economic growth requires much more than that policy-makers merely provide stable inflation. In this sense, we live in a post-Friedmanite and post-Thatcherite world.
