Tag Archives: Inflation

Spurious economic thinking from our politicians. Inflation is not the greatest of evils, in fact the opposite can be true

Over the last few days, there has been series of government ministers trotting out the same tired explanations of why a pay cap is necessary for the workers in the public service. These are two, the first is that the public finances are insufficient to finance a wage increase and that any such increase would only increase the national debt. There was the famous television broadcast in which the Prime Minister told a nurse that there was no magic money tree, an argument she has since undermined by her own actions. However what I want to demonstrate is the fallacious nature of the second reason giving for denying public sector workers a wage increase. This is the argument that it will be inflationary. The incorrect assumption these politicians make is that inflation is always bad. It’s not sufficient to say that taking a certain action is wrong because it can increase inflation. There are circumstances in which inflation can be good.

Price rises are welcome when the price increase is a consequence of the worker/s being paid a fair wage. Wages have fallen so low that nurses and other public sector workers are having to go to food banks so as to be able to feed themselves and their families. One of the unfortunate consequence is that now more nurses are leaving the NHS than are joining it. If we wish as a nation to have a health service that is able to deliver high quality care more money must be found to pay the health service staff. The cost of health care will rise but would this would be outweighed by the benefit to national as a whole.

The government would say that to increase the incomes of the thousands of public sector workers would be inflationary. These workers must continue to bear the pain of low incomes, as to do otherwise would be to threaten the nations well being. This is a totally fallacious argument, as what this inflation would represent would be a change in power relationships within the economy. Public sector workers will now as group have a much larger share of the nation’s incomes. As they spend there increased incomes demand for goods and services will rise and so will prices. One consequence of this is that other groups will find that there purchasing power is diminished.

There will be some unfortunate consequences in that workers in the private sector on low incomes will suffer disproportionately from price increases. However this could be offset by an enlightened government increasing the minimum wage to compensate for the reduced value of their incomes. Many workers will themselves solve this problem by transferring from poorly paid work in the private sector to better paid work in the public sector. There is within the economy an automatic adjustment mechanism, in that private sector employers will have to increase the wages they pay their staff if they wish to retain them. There is no great harm to be inflicted on the economy if inflation increases from its current rate of 2.9% per annum to 4 or 5%. This was the average rate of inflation throughout the 1950s and 60s and economic growth was then at its highest.

From within the private sector there will be siren voices arguing against this saying that they cannot afford to run their businesses with wage costs so high and that they will have no choice but to dismiss workers. Against this argument is the compelling moral one, if they are such rotten employers that they can only run their business if they pay wages so low that the employee is forced to turn to the food banks or to the government for wage supplements such as tax credits they deserve to close. There will be a temporary increase in unemployment and this will require a more generous approach to the payment of unemployment benefits from the government. This will only be a temporary increase, because the increased spending of the public sector workers will kickstart an economy which is at present in the merely idling mode. Economic growth will increase and so will the demand for newly unemployed workers.

One particular imagined scenario gives me pleasure. The City banker with an income of £100,000 plus will now find that as a consequence of the increased wages to the barista, there morning cappuccino will have increased from say £2.50 to £3.00. Having worked with such people I can imagine the indignation they will express at having to pay more for their coffee. Such people will see it as threat to their life style. Rich and super rich people will be able to buy less of the time of the less well off than they did formerly, which will hurt. There will be a return of the servant problem of the 1960s, when the rich found it difficult to recruit people willing to work long hours for low pay in personal service. Once wage rates and employment opportunities were available elsewhere the number of young women willing to enter domestic service dropped dramatically.

What needs to be prevented to stop inflation getting out of hand, is measures to stop the group that has most benefitted from the low wages of the past decade from over compensating for the loss in there purchasing power by disproportionately increasing their incomes. These people are those in the private finance sector, those whose wealth comes from large property holdings and company directors. This can simply be done by re-introducing a progressive income tax, together with a wealth tax and an effective capital gains tax.  The effect of these taxes will make it less desirable to earn excessive incomes, as a significant part of any increase will be taken in tax.  The tax take from this new taxes would help with funding of the public service sector.

There is one group that would be the losers from an increased inflation rate and that would be pensioners such as myself. The income I receive is fixed for a year and it would diminish in value as the year progressed, and although I do receive an increase in my pension at the end of the year equal to the new rate of inflation, that will not compensate for the erosion my income during the past year. However I will benefit from knowing that the health service is better funded and that my generation are the ones most likely to benefit from increased spending on this service.

Ignorance is the New Black (or the stupid things journalists say about the economy)

While listening this morning to an early morning radio programme I was struck by one of the comments made by the broadcaster. This comment was made during a discussion of the economic consequences of Brexit. She said  will it matter if the UK falls from being the seventh largest  to the eight largest economy in the world? This is an example of the typical remarks made by a member of the economically illiterate media.

Nobody with any understanding of economics wants a modest downturn in economic activity, because that modest downturn can easily turn into a catastrophic downturn. What journalists and politicians never seem to understand is that the economy is inherently unstable and decisions should never made that threaten the stability of the economic order. There are times when the economy resembles a house of cards and the slightest puff of the economic wind can send it tumbling down. Yet there are other times when the economy seems to be as a house built out of granite and is impervious to any economic storm. The problem is that it is difficult to tell before an event whether the current economy is structured like a house of cards or a house of granite. Only a fool would start an economic downturn, as history all too often shows that minor downturns become major ones. Unfortunately for the British people the political and media classes seem to filled with these economically illiterate people. Typified in the figure of the politician Michael Gove who during the Brexit debate said people where fed up of experts (economists) and did not need to heed their advice.

Politicians and journalists have forgotten that the collapse of the 2008 started when a minor bank Northern Rock collapsed. This collapse exposed the fault lines in the financial markets which led to the catastrophic collapse of the banking sector. It would have been more accurate to use an example from the USA but my knowledge of which minor bank there presaged the collapse of the banking system there is lacking. However what I wrote about the UK economy is true of the USA. The collapse of these minor banks would have had minimal impact on an economy that was sound, but as the economy was of a rotten construction it brought the house down.

The first fact to establish is that the British economy is far from being strong, it is in a fragile and perilous state. The Bank of England has recently reduced interest rates to a new low of 0.25% to offset fears generated by Brexit which threatened to  destabilise the economy. Prior to that the Bank of England has had to keep rates at 0.5% for several years. In a healthy economy interest rates of 5% or more would not destabilise the economy, whereas in a weak one a rise from the previous low of 0.5% to 1% would threaten to tip the economy into depression. The merest hint of a rate rise in America caused a minor financial panic.

The decision to leave the European Union (EU) is one such destabilising factor. After the initial vote there was some panic in the financial market and the pound fell to record low levels against the dollar and the Euro. If one major Japanese car manufacturer now located in Britain were to announce the cancellation of a major investment project, this would negatively impact on business confidence and could lead to copycat cutbacks in investment projects which would could lead to a recession. Nobody really knows which lever will be pressed which would start a major economic downturn in the UK, what can be said is the uncertainty generated by Brexit has revealed many potential vulnerabilities  in the UK economy each of which could lead to a major downturn.

When an economy is on its knees, what should not be done if the economy is get back on its feet, is give it a metaphorical kick in the teeth.  This is exactly what the ‘vote leave’ politicians and their supporters in the media have done.

What this journalist had in mind was probably the modest falls in national income predicted by economists when accounting for the expected increase in inflation caused by the fall in the value of the pound. The expected fall in income will  be between 3% and 7% (Wyn Lewis ‘Mainly Macro” blog) for somebody on an income of £100,000 it’s a loss of £3000 a year. An unwanted cut but quite affordable. If it was an income of £60,000 it would be a loss of £1,800, again affordable but unwelcome. However for a person on the median income of £27,600 a cut of £828 will mean some bills go unpaid. Those on lowest income bracket who at present are just about able to pay their bills out of their limited income will find a cut of 3% catastrophic. Even with such a small cut in their incomes they would be unable to pay many of their bills. Any greater fall in income would push thousands if not millions into a life of despair and utter misery.

The previous paragraph makes the assumption that the fall in the incomes of all would be between 3% and 7%, but in an economy in which wealth and power are unequally distributed, the powerful (the upper middle classes) will be able to minimise their income loss and ensure that the less powerful take the greatest hit to their incomes. Broadcast journalists at least those who are national broadcasters on a BBC radio programme can bargain for increased incomes to offset any cut in their income due to rising inflation. The BBC would not want to lose a well known voice or face, as they know these well paid journalists could easily find employment elsewhere. This years pay cut (inflation imposed) of £3,000 can be next years pay rise of £3,000. 

The position for a person in the precariat, such as self employed delivery drivers or care workers on zero hour contracts will be dire. They are in weak bargaining position and will have to accept in full the cut 3% cut in their real wage. Demanding a pay rise to offset the fall in their real income caused will likely lead to the individual being unemployed, as the employer can find alternative workers willing work for the now reduced income. The government in response to falling tax revenues caused by the falling national income will cut in work welfare benefits such as working tax credits. Resulting in a further fall in income for these workers. The businesses who employ such workers will be experiencing falling sales and to maintain the income they derive from profits will make further cuts in wages. Whatever happens to this much larger group the sheer volume of their numbers mean that the cuts to their income will substantially reduce the national income, leaving scope for above average pay increases for the lucky few.

To conclude ignorance is the new black, when speaking about the economy as Michael Gove said you don’t need to be an expert. Whatever is the received opinion at the dinner parties in Notting Hill or whoever the well-off congregate for social events, is the truth about all matters economic. People can without any sense of shame boast that they are terrible at maths, people ignorant of economics don’t even feel that minimal shame. The billionaire who approached David Cameron at a social event who said that the solution to the UK’s unemployment problem was to abolish the minimum wage represents the sophistication of the level of thinking in this group.

This is not the way to manage an economy

Sometimes I think economic policy making can be best explained through stories, with ogres, giants and other mythical figures from folk tales wreaking havoc on the economy.  Contemporary policy makers are obsessed with the ogre of inflation, although that particular ogre was slain years ago.

The events of the 1970s traumatised the political classes in the West. There are two explanations of the inflation of the 1970s, one is that the world economic system became increasingly dysfunctional in response to political crises such as the Vietnam war and the actions of OPEC in raising oil prices to cripplingly high levels. However that explanation became disregarded and instead policy makers focused on what they termed cost push inflation. Workers by pushing for above inflation pay increases were causing inflation to spiral out of control. This inflationary spiral was given further impetus by excessive government spending, this spending increased faster than the capacity of the economy to increase output of goods and services and in consequence prices rose (demand pull inflation).

Rather than accepting the inflation of the 1970s was due to a series of one off events, they believed that the cause was a malfunctioning economic system. Inflation had to be squeezed out of the system through controlling wages and reducing government spending.  This caused in Britain the recession of 1981 in which it lost 20% of it’s manufacturing capacity and a massive increase in unemployment. This policy was counted a success as inflation was reduced to historically low levels. The policy of limiting the increase in incomes has been so successful that in the USA the incomes of the majority have remained unchanged since 2003 and in Britain since 2008.

However the economic is a dynamic creature and cannot be constrained within  policy straight jacket. Businesses that have successfully limited the incomes of their employees to keep down costs are now faced a new problem. People on low or stagnant incomes don’t buy lots of goods and there was a danger than stocks on unsaid manufacturing goods would build up. Mountains of unsold goods would diminish the profitability of these businesses.This certainly seemed to be true of the motor industry, where for year on year output of cars exceeded demand for them. There was some reduction in capacity, the closure of much British owned car manufacturing. However a dynamic economy will soon go into reverse if demand for goods is not maintained.

If rising demand could not be financed from ever increasing incomes, an alternative had to be found. The alternative was to be consumer credit. At first the credit came from the ever increasing use of credit cards and from loans raised on the security of ever increasing house prices. Growth was driven by the ever greater use of credit. Banks cooperated by making increasing amounts of money available on ever more generous terms to finance house purchases. All this extra money in the housing market pushed up house prices, which in term increased the value of assets (houses)  on which loans could be raised. Any economy whose growth is dependent on ever increasing levels of consumer debt is inherently unstable. Debt financed trade is particularly vulnerable to adverse changes in the economy. A rise in interest rates can lead to a crash in demand as people can no longer afford to borrow at the new higher rates. This happened in 1990, 1999 and 2008.

The unvirtuous circle

When economic growth is dependent on ever increasing levels of consumer credit, extraordinary steps have to be taken to keep consumer credit growing. In the years immediately preceding 2008 banks and other financial providers took increasingly less prudential steps to keep the level of consumer credit growing. Applicants for mortgages if self employed could self certify their income, mortgages were increased to 125% of the value of a property and to make possible the purchase of increasingly expensive properties the time over which a mortgage could be repaid was extended from twenty five to forty years. The whole financial sector was gambling that house prices would increase at an ever increasing into for the indefinite future. This could not continue forever and inevitably the whole system came tumbling down in 2008, resulting in the greatest recession since the great recession of the 1930s.

Rather than taking the difficult step of rebuilding the economy on sounder lines, the government took extraordinary steps to stoke up the credit bubble. Interest rates were reduced to record lows, so people could continue in their risky habits of funding expenditure from credit. The government poured record amounts of money into the banking sector to keep rates low and to ensure that the banks had plenty of cash to lend for the various speculative activities that would fund the demand for goods and services that would keep economic growth going. Strangely enough they were abetted in this by the employers who would keep wages low as possible, but who would instead give those same employees whose income they froze, access to the most generous of terms for credit. Since the crash there has been a rapid growth in what is called shadow banking, a system where the manufacturers rather than the banks provide credit. One such example is the credit hire or leasing system for the purchase of cars. A system whereby the buyer leases a car for a period of say three years and then returns the car to the dealer and then takes out another car on a lease. While car leasing is not unsound, it becomes unsound when it becomes part of an ever increasing credit bubl. Leasing as with another system of credit is particularly vulnerable to any adverse change in the economy.

One such event was last Friday when the result of the referendum was announced. A debt driven economy will be easily upset by such an event. There has been since Friday a rapid collapse in the share prices of banks and other financial institutions, as any adverse change in the economy makes it more likely that there will be an increase in the rate of default and the profits of the banks will be particularly badly hit.

The great mystery is why conservative businessmen who will use any method to keep down or reduce the wages of their employee’s down and yet will throw increasing amounts of cash to enable the same employees and those of other businesses to buy goods on credit. To this particular economist this is the riskiest of economic strategies, yet governments encourage such practices. The only conclusion that I can arrive at is that rather than these businessmen being the great leaders they are lemmings that follow the worst instincts of the herd.