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The end of Bank of England’ Governor Mark Carney’s eight-year tenure is not far away, and his successor will inherit an economy that is again, on the whole, very healthy.
Its main problem, the public has come to believe, is that inflation has been too high for too long, making it harder for the nation to spend money. This perception is largely true: Consumer prices have steadily accelerated to two-year highs.
But there is another side to this story. The increase in inflation might well have been a good thing. For a decade and a half in Britain, inflation has been consistently and worryingly low.
The Bank of England’s Monetary Policy Committee embarked on an aggressive tightening of monetary policy in the early 2000s. A period of extraordinarily low inflation — only 0.4% at its peak in 2003 — seemed to indicate that low rates of interest were no longer necessary and would gradually lead to a return to the inflation rates of the 1980s and 1990s.
Then, in 2007, the global economy entered the next phase of a post-recession period of very low inflation. In recent years, low inflation has been accompanied by another trend: rising wages. So, to some extent, Britons’ appreciation of rising inflation is the opposite of their memories of negative inflation.
To be sure, the UK is in fact one of the best countries in the developed world at managing inflation. As business columnist Chris Giles put it in a Financial Times column on Thursday, his view is that “inflation has not been too high for a very long time. It’s even less high than Canada’s.”
Its average annual inflation rate over the past five years has been just 1.7%. In Canada, where inflation has been running at two-and-a-half to three percent over the past half century, the average is 2.5 percent.
Apart from the short term threat of inflation to consumers, the Bank’s forecasters are predicting a decrease in both inflation and wages over the next few years.
In their “Inflation Report” this week, the Bank gave several reasons for this decline. Those reasons are heavily influenced by events outside the UK. Oil prices are about 30 percent lower than they were six months ago. The US dollar has been rising — indeed, it is up 15 percent against the British pound since the beginning of the year — which is making imports cheaper. And, of course, the government’s focus on its austerity program is also reducing consumer spending.
There are also worrying signs about the possible effects of the US Federal Reserve’s decision in September to raise interest rates in the face of continued economic growth in the United States. The BoE reported on Thursday that “the pick-up in global growth during 2018 has been weaker than the international forecasters had expected,” which is potentially bad news for the UK, where investors have been looking for positive signs from a growing economy in America.
It is clear, however, that the rise in inflation is part of a structural problem. The pressure on wages has been driven by rising productivity, not by wage increases in the way that the legacy of the Great Recession can be blamed on wage cuts. Inflation is meant to be a byproduct of rising output — the natural response to increases in productivity.
Both Carney and George Osbourne, Chancellor of the Exchequer, have made the point that some inflation this year is good for the economy because it reduces uncertainty. Unemployment is at the lowest level since 1975, leaving people with a lot more cash to spend.
Add in the debt-free benefits to consumers that are being delivered by a flat-lining government budget, a weak pound, and the fact that 3 million people who wanted a new mortgage have now been given one, and it is understandable that people may feel a bit more complacent.
The Bank of England’s muted assessment of its inflation forecast, suggesting that it is both realistic and maybe even anticipating just the sort of modest impact on consumers that might be good news, may end up doing the opposite.
The Bank’s chief economist, Andy Haldane, thinks people need to be more patient. In a statement published on Wednesday, he said that “low inflation is a guarantee against destitution and stagnant incomes. It’s another half-century of stable living standards. It’s the health of our social contract. And it means we can afford to take a few risks with the economy’s recovery.”