How big a danger is rising inflation? This is one question the Bank of England’s monetary policy committee will discuss next week.
Given the huge uncertainties about the path of the pandemic, it is futile to provide numerical forecasts. What we can do, though, is consider some of the mechanisms that might move inflation next year.
You might think that one of these is simply that the Bank of England has been printing money: it’s done a further £310bn of quantitative easing this year, and might well do even more soon. This increase in the money stock, however, is more or less matched by increased demand for money as cautious savers and financial institutions seek liquid assets as protection against uncertainty. The notion that rises in the money supply necessarily lead to higher inflation is not corroborated by the facts, and is unlikely to be so this time.
In fact, there are two disinflationary factors.
One is that unemployment is likely to rise a lot. Although Chancellor Rishi Sunak increased employment subsidies last week, this came too late to prevent some job losses and his measures do nothing to promote job creation – which is essential to merely stabilise joblessness. Higher unemployment tends to reduce inflation not just by holding down wage growth but by depressing consumer demand.
Also, uncertainty itself holds down inflation. Columbia University’s Michael Woodford shows that it tends to stop firms raising prices: why risk alienating some customers if you might not need to?
On the other hand, though, there are reasons to expect inflation to rise.
One is merely administrative: the cut in VAT on the hospitality sector will end in January.
Others, though, are more fundamental.
We’re already seeing one. The nascent upturn in China is raising raw materials’ prices: the S&P GSCI index is already 60 per cent up from April’s lows. This will gradually raise costs and prices in the UK.
Also, it’s possible that high unemployment won’t do much to hold down inflation, because there’ll be a mismatch between the jobless and the vacancies that are available. Unemployed waiters and baristas won’t quickly become (say) customs officials, which means wages of the latter won’t be bid down. In the 1980s, we saw highish inflation coexist alongside mass unemployment because many of the jobless didn’t have the skills or lived in the wrong areas for the jobs that were being created. We could see a repeat of that.
What’s more, the swathe of business failures we are seeing and will continue to see are themselves inflationary simply because they reduce competition and so increase the (local) monopoly power of the survivors: the more coffee shops close, the less reason there is for their surviving rivals to hold down prices.
On top of all this there is a Brexit effect, the magnitude of which is still uncertain. The problem here is not so much higher tariffs but non-tariff barriers – the cost of complying with customs regulations which would raise transport costs. HMRC has estimated that, if we leave the EU without a deal, these could add £15bn a year to companies’ costs – equivalent to 0.7 per cent of pre-pandemic GDP. Some of these could be passed onto UK customers. Also, new VAT rules might deter some smaller European sellers from selling into the UK market – which would diminish competition and hence raise prices.
You don’t therefore need to panic about the effects of “printing money” to suspect that inflation might rise.
History, however tells us not to worry much. Since the early 90s, CPI inflation has been reasonably stable despite huge swings in sterling, commodity prices and economic activity. Which tells us not to expect a very sharp rise.
Even if it does rise next year, then, inflation is not a huge danger. The Bank of England is therefore right to focus more upon supporting the economic recovery.
