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Inflation - Doubling troubles

Doubling times provide an intuitive explanation of the impact of higher inflation
June 29, 2022
  • UK CPI inflation has hit 9 per cent, soaring past the Bank of England’s 2 per cent target
  • At 2 per cent inflation, prices double every generation. At 9 per cent inflation, this process takes just eight years

CPI inflation in the UK has hit 9.1 per cent. This represents the highest level since 1982, overshooting the Bank of England’s 2 per cent inflation target by more than seven percentage points. And this means trouble for governor Andrew Bailey. If the Bank misses its target by more than one percentage point either way, he must write a letter to the chancellor explaining both the reasons for the divergence and the Bank’s strategy for bringing inflation back on target. In terms of UK monetary policy, 3 per cent inflation is undesirable. But how much worse is 3 per cent than 2 per cent? And how much worse is 9 per cent than 3 per cent? 

Doubling times can provide an intuitive interpretation. At a stable 2 per cent rate of inflation, general prices double every 35 years. The picture is muddied by the fact that inflation is calculated using a basket of goods, meaning that the price of some items would increase by more than 2 per cent annually over the period, and some by less. But as a rule of thumb, a basket of goods will take a generation to double in price when inflation runs at 2 per cent.

As my chart shows, at 3 per cent inflation, this doubling takes around 23.5 years: a significant hastening, but still a reassuringly long time period. At 5 per cent inflation, the doubling time shrinks to 14 years. And at a sustained rate of 9 per cent, prices double in just eight years. 

This acceleration is uncomfortable enough. But the problem is intensified by the fear that inflation of 9 per cent is unlikely to hold steady. At high inflation rates, workers try to maintain living standards by asking for inflation-busting pay rises. Wage hikes increase business costs, which are then passed onto consumers in the form of higher prices. Wage demands then rise again as households try to keep pace with inflation, and the economy enters a dreaded wage-price spiral. 

In extreme cases, this can even tip over into hyperinflation, where increases in the general price level happen at breakneck speed. Steve H Hanke from John Hopkins University has identified 57 historical cases of hyperinflation, defined by inflation rates greater than 50 per cent per month for over 30 days. Belarus, for example, had a ‘mild’ case of hyperinflation in 1994, with monthly inflation hitting 53.4 per cent. Prices doubled in just 49.3 days. In Zimbabwe in 2007, monthly inflation hit 4.19 × 1,016 per cent – a mind-bending number rendered easier to understand in the context of prices doubling every 15 hours.

That is not to say that the UK economy risks anything close to these levels: if anything, inflation looks more likely to come down over the next 12 months than go up. Paul Dales, chief UK economist at Capital Economics, argues that although inflation has not yet peaked, this month’s release showed no obvious signs of persistent inflationary pressures. According to the CBI’s monthly Industrial Trends Survey, firms’ expectations for higher prices decreased this month, with signs that weaker activity is beginning to slow the rate of price increases. The Bank of England, for its part, expects the rate of inflation to slow next year and return to close to 2 per cent in around two years’ time. 

Doubling times can provide a useful rule of thumb for investments, too. Firstly, they provide a reminder of the importance of keeping an eye on management fees, as Mary McDougall stressed earlier this month. Take an investment returning a healthy 6 per cent. With an annual cost of 0.5 per cent, its nominal value will double in 13 years. With costs of 2.5 per cent, the doubling time stretches to over two decades.  Doubling times also illustrate the importance of keeping pace with inflation – currently easier said than done. Allow for an optimistic 2 per cent rate of inflation, and the latter investment would take almost 47 years to double in real terms: a troubling doubling time indeed.