Why is inflation our enemy and what is worse?
Posted on Tuesday, September 13, 2016 by Terry Brame — No comments
Inflation figures, released today, show the rate holding steady at 0.6%.
This means the average price of everyday household goods and services has risen by about half a per-cent during the last 12 months. Doesn't seem much, and indeed it isn't, so why is so much importance attached to it?
Inflation is probably the Governments biggest economic worry. For the last few years, controlling the rate of inflation has been the main, if not the only, responsibility of the Bank of England who are charged with making all the necessary fiscal decisions to keep it under control. If they fail in this task, the Governer (Mark Carney) has to write to the Chancellor explaining why they have failed and this often results in detention, lines or (at worst) a damn good thrashing. But why do they get so worried about a phenomenon that, during the 1970's, was as much a necessary evil as the common cold?
Inflation impacts upon society in many ways and each of these ways has one thing in common. They are all 'political'. By which we mean that they affect the way the public (me and you) think about the way the country is being run. Anything that has political consequences scares the Government to death because it causes instability and gives the electorate a reason to criticise MP's.
Inflation erodes the value of our wages. When this week's food bill becomes so much more expensive than last week's we have no alternative but to ask our boss for a pay rise in order to feed our family. If he agrees he puts up prices and this filters through the system so that, this time next month, we are back again asking for more. A vicious circle begins that is extremely hard to break.
Inflation discourages saving. You may think that your savings are sitting safely locked away in the bank vaults gathering interest but they're not. They are being used for that most important of economic functions, 'Investment'. That is, providing things like machinery, roads, buildings and technological gadgetry that help businesses grow and prosper - Capital, in other words. Without consumer 'savings' - and basically that means everything that isn't 'spending' - the bank would have no money to lend to Companies who need to build a factory to expand their operation and employ more people. If your savings are simply being eaten away by rising prices, you have no reason to continue to save and money for investment becomes more expensive.
So, inflation reduces the standard of living and can lead to unemployment, two things that Govrnments fear. One way of controlling inflation is to raise interest rates to reduce the amount of cash in the system to discourage over-spending and rising prices. It becomes more expensive to borrow and more attractive to save. However, one of the problems the Government currently has is that it needs to encourage consumer spending to get the economy going again after the economic recession. Interest rates are virtually 0% at the moment. (This is not what you and I pay, but what your bank pays to the Central Bank (Bank of England))
However, there is one thing the Government fears more than inflation. That is 'De-flation'. Where prices start to drop, consumers stop spending altogether because they are waiting for goods to get even cheaper. Deflation is rare, but not unknown and was, in fact, very common in the late 19th and early 20th century.
So, that 0.6% inflation figure may be good news for our mortgage but is a constant worry for the Treasury, The Bank of England and the Government because they know that, by the time it becomes our problem too, it might be too late.