Inflation ahoy!

[Saracen]

actually your wrong, i work in a purchasing department and work alongside buyers and alot of the companys are asking for a 10-20% price increase on their products and the buyers are excepting them, the company isnt but thats a different matter, obviously not all of that is past onto the consumer

I think JPreston is talking about an inflation level. Some products may well have gone up 20%, but others will have stayed the same and some will have gone down, especially as sales bite. What's the overall effect?

That's one of the problems with talking about inflation .... precisely how do you measure it? CPI, RPI or RPIX? Or "personal" inflation? And on that latter, the figure you get will depend on the buying habits of the individual, their product mix, their general affluence and even where in the country they live.

The same problem applies to any generalised discussion of the effects of inflation. Like so many things, it's neither entirely good nor entirely bad. There certainly are aspects to inflation, provided it's not excessive and provided it's relatively steady, that are good for the economy. But even those aspects that are good for the economy might well be bad for individuals, and typically, those lower down the income scale will suffer the most, even from moderate inflation.

Nor do things necessarily work the way people might expect. For instance, Gordon Brown gave the BofE MPC control over interest rates, but then defined their target as inflation control as measured by the CPI. But, as prices go up, inflation climbs and you cut interest rates to try to have a deflationary effect, you'll also make Sterling less attractive (interest rates down) which will mean Sterling falls against some other marker currencies. And if it falls against, for instance, China, and we're importing huge volumes of electronics and clothes from China, then a falling exchange rate makes those imports more expensive, which is inflationary .... which is precisely the opposite of what was supposed to happen as a result of cutting rates.

And, of course, the figure that the MPC use to measure inflation, the CPI, doesn't include mortgage interest, so cutting interest rates generally, which has the most pronounced and immediate effect on mortgage rates (usually) doesn't feed back into the CPI directly via mortgage rates, but only via the indirect effect that reducing mortgage payments may have on discretionary spending.

Gordon Brown shot himself in the foot a bit in that regard. Defining the MPC's targets as CPI worked like a charm for years, because it kept mortgage rate rises, which have been happening for quite a while now (and things like rent and council tax, by the way) from having a direct impact on CPI, with the result that CPI and RPI have been diverging for some years, and the average rate of RPI (RPI04) has been tending up must faster. It's currently sitting, for anyone interested, at more like 4.2% and about 4.3% for the year to date, as opposed to the 2.0% to 2.1% the government like to talk about when they discuss their performance on inflation.

Inflation is not a simple subject, and any discussion of it needs to remember that whatever statistic you use, it's a generalisation.

[kalniel]

Well it's having no effect on houses anyway - LIBOR has largely detached from the BofE interest rate.

Credit crunch is still in effect and it's still hard to get money for a house, but we've got less interest to pay on our credit cards so can splash out at Christmas and boost the economy Over-optimist view is that it's the best of both worlds - house prices will continue to flatten in sterling, and sterling will drop a little, while the economy keeps going strong

[JPreston]

actually your wrong, i work in a purchasing department and work alongside buyers and alot of the companys are asking for a 10-20% price increase on their products and the buyers are excepting them, the company isnt but thats a different matter, obviously not all of that is past onto the consumer

Actually I'm right, and I would know

[educatedfool]

Prefer the Beef Broth myself. Heinz that is. I wouldn't shop at Lidl, I might be working class, but I'm not a pikey.

I had some wild sammon from there tonight and it was better than most I've had from other, more expensive places.

[mcmiller]

Actually I'm right, and I would know

oh thats right I forgot you work at the same company as me

[Rave]

I still have almost no understanding of economics but I like the idea of inflation as opposed to a house-price fall. If the my house is over-priced and must fall in real terms, then I'd rather it held it's nominal value and sterling itself dropped, because that way Rave's rent goes up and the value of his deposit falls alongside it

I love you too sweetie. No rent increase this year, happily. If I was saving up a deposit for a house, it wouldn't be in sterling. Right now it'd be in gold, I reckon.

[Rave]

But, as prices go up, inflation climbs and you cut interest rates to try to have a deflationary effect, you'll also make Sterling less attractive (interest rates down) which will mean Sterling falls against some other marker currencies. And if it falls against, for instance, China, and we're importing huge volumes of electronics and clothes from China, then a falling exchange rate makes those imports more expensive, which is inflationary .... which is precisely the opposite of what was supposed to happen as a result of cutting rates.

Nope- cutting rates is inflationary, and raising them is deflationary- the series of rate rises earlier this year were precipitated by CPI heading north of 3%.

And, of course, the figure that the MPC use to measure inflation, the CPI, doesn't include mortgage interest, so cutting interest rates generally, which has the most pronounced and immediate effect on mortgage rates (usually) doesn't feed back into the CPI directly via mortgage rates, but only via the indirect effect that reducing mortgage payments may have on discretionary spending.

It's fairly sensible that mortgage interest doesn't feed back directly into the measure of inflation used to set interest rates- otherwise you'd have a positive feedback effect. My problem with CPI as a measure is that I think the 'basket' doesn't come anywhere close to approximating the true cost of living in this country.

[JPreston]

oh thats right I forgot you work at the same company as me

I don't think I need to draw you a Venn diagram here but in the notation of set theory:

{People talking specifically about Tesco} = {me, everyone "seriously claiming ~20% price inflation at Tesco"}\{mcmiller}
{People talking about wherever it is mcmiller works} = {mcmiller}
{tesco}intersection{wherever it is mcmiller works} = 0
|{insights into tesco price inflation that mcmiller has gained from his place of work}| = 0

[mcmiller]

LOL!!!

You dont actually know which company i work for, it could well be tesco or another supermarket company but as you seem to know where i work and what products i was referring do tell ?? no doubt your response will just be a sarcastic comment lol

[JPreston]

You work Tuesdays to Saturdays in the sandwich shop next to the SPAR at the bottom of Meadowsley Road, Telford.

[JPreston]

no doubt your response will just be a sarcastic comment lol

You read my response before editting in that comment!

[mcmiller]

You work Tuesdays to Saturdays in the sandwich shop next to the SPAR at the bottom of Meadowsley Road, Telford.

blimey how did you know

[TheAnimus]

What about the christmass tree price index (CTPI)?

Am i the only one shocked by that!? All the nice breads are extortion this year.

[Saracen]

Nope- cutting rates is inflationary, and raising them is deflationary- the series of rate rises earlier this year were precipitated by CPI heading north of 3%.

That's right ..... and wrong, which was the point I was making.

Inflation (and deflation, which strictly speaking is not the same thing as the negative inflation or disinflation) are complex, not least because it depends whether you're talking about demand or supply side influences causing the problem, and because it depends on whether you're talking about inflation coming from pressure from productivity or monetary influences, and because it depends on whether the raising or lowering of interest rates will directly affect the cause of the problem (which will be different if the problem is an imbalance between domestic supply side of goods, i.e. industrial productivity or whether it's external effects like a credit squeeze from the US or imported energy prices), and because it depends on whether the root cause you're seeking to address is permanent or temporary, and if temporary, how deep it will go and how long it will have an effect for.

In terms of Economics 101, you're right about the inflationary effect. And while that's fine for basic economic theory, reality is FAR more complex than that. So, when you make a change to interest rates, either up or down, it will affect a number of different economic trends, in different directions and to vastly different extents, and over different time periods. It's certainly true that basic monetarist theory predicts the effect you ascribe, but the problem is that basic monetarist theory makes assumptions about the simplistic state of the economy that simply don't hold true in real life.

For instance, increasing interest rates should decrease the demand for money, because it makes it more expensive to borrow and therefore less appealing. But even that has complex effects. For instance, if you raise interest rates, you raise the returns offered on government bonds, which makes them more appealing to investors. If they start to become attractive compared to foreign bonds, overseas investors will start buying sterling in order to buy the bonds because of the comparative rate of return, so the demand for money goes up to some extent, mitigating the decreasing demand for it caused by making it more expensive. And if the exchange rate changes, so does the economic effects of exchange rates on both imports and exports, which can cause sector distortions. Take a look at the effect on the Canadian economy in the late '90s, caused by government interest rate manipulation and the Asian "crisis".

Whether a cut in interest rates causes inflation to go up or down depends on the situation the economy is in at the time, because it causes reactions in BOTH directions, to differing extents and over different time frames. Which effects will have greater magnitude depends on a whole series of factors, and the situation we're in now isn't the same as the situation we were in a year ago.

As for

- the series of rate rises earlier this year were precipitated by CPI heading north of 3%.

Erm, no. The rate rises were precipitated by, again, a complex series of factors, not withstanding the fact that at least one of them occurred when the rate had already peaked at some 3.1% and was heading down and predicted to reach the 2% target over the next year. No, the concern was medium term growth and stability in the face of what appeared stronger and more stable growth in the international economies than previously expected, resulting in lower than anticipated disinflationary pressures. Oh, and couple with that the fact that inflation forecasts had been based on market expectations of another rate rise in May, and issue was how big it was going to be. Strong market expectations can be dangerous to buck without very good reason, if only because much of confidence relates to predictability and stability.

That's one of the things make makes the Bank's job hard and economic predictions of the effect of interest rate changes 'interesting' .... the human factor. So much of it is about confidence. A couple of years or so ago, the bank cut interest rates largely because consumer spending had fallen more sharply than expected after previous rate rises, and mortgage costs and the high level of household debt were such that a concern existed over triggering a slump, or even a recession, caused by reductions in output as a result of diminished consumer confidence. This was mid-2005 and if you remember, there were rumblings then about recessions, about house price collapses and so forth. Well, the bank cut rates 25 points and that seemed to signal a reversal in consumer doubts and everyone went back to buying again .... because of the effect on confidence, not because of the monetary effect of the cut.

Economic models make it very hard to predict what rate rise will do, partly because there's so many factors, often pushing in opposite directions, and partly because the confidence factor is hard/impossible to quantify. Which is why circumstances are so different now to earlier in the year. We've seen a significant slowdown in house-prices, even a slight reduction (which might , of course, be the start of either a long slow trend or even a collapse, or it might not), with the implicit effect on consumer confidence, together with LIBOR pulling away (upwards, obviously) from the repo rate, and a general credit squeeze, both in consumer and industrial terms, and the shakiness of confidence from things like Northern Rock.

We'll find out in due course exactly what the MPC had in mind with this latest rate change, but I'll bet it isn't concentrating on the CPI. It'll be about far more than that, and I'd further bet that confidence will be a key element. This is essentially a Keynesian view of money, in the sense that both income velocity of money and his M2 "speculative" motive (as opposed to transaction motive or precautionary motive) are largely psychological factors, and that whilst you might stand some chance of predicting the impact on exchange rates, bond markets and so on, you don't stand a prayer of accurately predicting the speculative reaction as it impacts on confidence. That's why, in that 2005 rate change I mentioned, about half the MPC wanted a 25 point rate cut and the slight minority (5 to 4 IIRC) wanted no change, and why the May 2007 decision was an argument over whether the increase should be 25 basis points or 50 .... with the more conservative 25 point group winning out, unanimously in the end.