Inflation is a profound evil – getting it under control is vital
4 min read
A new generation in Britain are discovering the hardship of high inflation. For a long time we have taken price stability for granted. Occasionally one heard a suggestion that a little bit of inflation would be no bad thing. Few people can think that now.
Inflation is a profound evil. It cheats savers, undermines living standards, promotes instability, labour unrest and undermines confidence.
Inflation is the most important immediate problem we face. This is not to downplay growth, but we cannot have sustained growth without first getting on top of inflation. Sound finance, stability and low inflation are the preconditions for growth.
The May inflation rate of 8.4 per cent was disturbing. Inflation stopped falling and core inflation, excluding food and energy, actually increased as did services inflation. Annual wage growth rose to 7.2 per cent compared with 5.2 per cent in the Eurozone and the United States. We are at risk of embedding the current inflation rate.
The hope that tax cuts and growth, if it materialised, would lessen demands for higher wages in the tight British labour market seems illusory
Is the United Kingdom an inflation outlier? Our rate is higher than that of France, Germany or the US but Italy is only marginally lower. Ten EU countries have higher CPI inflation rates.
Some economists argue that the UK has "the worst of all worlds" in that we suffered the energy shock of Europe and the labour shortages of the US. Our unemployment rate is only 3.8 per cent with a million vacancies. It is difficult to believe we can return inflation to the Bank of England’s target of two per cent without some contraction in activity – hopefully not a recession. We need to realign demand with weaker supply. Of course we also have to do all we can to increase supply but, whether that is food energy or components, that takes time.
The Bank of England has put up rates by a full half point. Some criticise this as a one club golf policy. But what are the alternatives? Price controls only tackle the symptoms. Another alternative would be to tighten fiscal policy, putting up taxes or cutting spending, but this is a cumbersome process. Interest rates can be adjusted quickly in either direction.
Others argue the reverse. We should pursue higher real incomes through economic growth and targeted tax cuts – with one bound Jack would be free. But the hope that tax cuts and growth, if it materialised, would lessen demands for higher wages in the tight British labour market seems illusory. If such an approach could ever have been on the cards it plainly cannot be now after last year's mini budget. Challenging the current approach risks upsetting market confidence.
Understandably people are concerned about the impact on mortgages. Changes in the market to more fixed-rate deals mean that the impact of interest-rate changes take longer than in the past. Some 1.3 million people have fixed-rate mortgages expiring in the 12 months from the 1 July. So far, the mortgage holders have been remarkably resilient. This generation of mortgages were lent more cautiously than in the past. The affordability tests imposed by the Bank of England mean that many borrowers already have a decent margin to cope with shocks, but flexibility and help from the banks as during Covid will be necessary.
Some voices have called for a mortgage rescue package. But it is not sensible for the Bank of England to bear down inflation by raising rates and at the same time the government to subsidise them. Nor is it equitable to ask those not owning houses, struggling with food and energy bills, to subsidise those on the ladder.
I continue to support the independence of the Bank of England, but the credibility of the bank is at risk today. In the recent past it has not sounded let alone acted as though it was determined to defeat inflation. In 2021, the bank continued with quantitative easing, even when it became inappropriate as prices accelerated and distortions in asset prices were obvious. When Andy Haldane, the Bank's chief economist, warned the inflationary tiger was stirring, he was ignored.
If the Bank is to regain the confidence of the public it needs to focus harder on its core objective of defeating inflation. Some people want to pretend there are easy answers but there are none.
We should not give way to despair. We are not alone as a country in experiencing this fall in living standards. Much the same has happened in Germany. We can all get inflation under control and after that we have the opportunity for growth. But getting inflation back to target must be the first priority.
Lord Lamont, Conservative peer and former chancellor
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