Inflation remains at 2.7% for fourth month

Inflation stability is the aim of the policy makers. It allows for certainty in business, anchors inflationary expectations and brings confidence back to households.

So the news that inflation has remained at 2.7% for the fourth month in a row is good news?

Of course there are some prices rising faster and some slower, but stability is good news in many ways. However at 2.7% it is 'above the 2% target, while still within the +/- 1% band that causes the MPC to explain themselves.

The greatest concern about 2.7% inflation is that earnings are going up more slowly. This means in real terms most people are worse off.

There are some other concerns. The inflationary pressure is mainly cost-inflation. Ironically some demand-pull inflation would have been nice as it would represent a return to growth. Also the recent devaluation of the pound will lead to higher import prices and this will feed directly into the CPI.

The Guardian covers the latest inflation figures here

Inflation makes a surprise upward move

Lots of people are expressing their surprise at the rise in inflation to 2.7% (from 2.2% last month).  I'm not sure we really should be that surprised or that worried.

Inflation is the CONTINUOUS RISE in the general price level, reducing the purchasing power of real incomes. This rise is due to three main factors:

1. A rise in university tuition fees.
2. A rise in food prices due to the poor weather
3. A rise in energy bills

The Bank of England is supposed to keep inflation at 2%, but are allowed a 1% margin before they have to apologise. Should they really be concerned with this rise?

Well 2.2% was a 34 month low for inflation and so things seemed to be coming back under control, so this will be a blow to the men from Threadneedle Street. But the first two factors that caused inflation must be seen as 'one-off' influences. Tuition fees will not rise as much next year (from £3k to £9k this year) and it is unlikely that the awful weather of this year will be repeated next year.

So both the first two influences will drop out of the index next year. As for energy bills this market is known to be volatile and so there is little that can really be read into the price rise in terms of future inflation.

Also inflation is really concerning when it affects everybody. Tuition fees affect only a small proportion of the population, but the current massive rise makes the index jump significantly despite the small weight it is given in the basket.

So the Bank of England will almost certainly carry on looking at underlying inflation when setting interest rates and not the headline figure. Overall demand remains weak and while there are encouraging signs of recovery it is unlikely that interest rates will rise until well into next year even so.

The Daily Telegraph has a good explanation of inflation trends here

Inflation falls, but not for long?

The CPI and RPI fell by 0.3% last month. That is good news for the MPC and keeping to the inflation target and is the lowest rate on CPI since November 2009.

The cause of the fall in inflation illustrates that the figure is a moving average. A year ago gas and electricity prices rose significantly, but this year they did not. Of course there were other price rises but not as much as a year ago.

The importance of the September inflation figure is that it many benefits are increased in line with it. So its important for next years Government spending and the fall in inflation is good news for George Osborne.

The BBC covers the story and shows both the influences on the current inflation rate and reviews the benefits that are affected. There is also a section on why lower inflation is good for some people and firms.

The BBC story is here

From market prices to inflation

Markets set the prices for individual goods. Inflation is the continuous rise in the general price level. Of course we are taught that we must not confuse the two. When the price of a particular good rises this is due to either a rise in demand or a supply constraint, not inflation. But surely there is a connection?

The issue of food prices is a good example of where we can link market prices and inflation. Food prices generally are about to rise due to several factors:

1. The wet summer in the UK has led to a lower harvest and it is proving difficult to plant next years crop.
2. There have been droughts in the USA, Russia and southern Europe during the growing season.

This means that cereal prices overall are rising. It's due to a supply shock, relative scarcity has increased.

But this is going to feed through into inflation as it will cause a wider impact on prices.

Clearly the goods which use soya, wheat etc will have to pass on the extra costs. The price of bread for example. But cereal crops are also used to make biofuel and to feed animals. So we can, at the very least, expect the price of meat to rise too.

While these are changes in relative prices of individual goods this will feed through into inflation. Food is a significant item in average household budgets and so has a significant weight in the CPI. The rise in food prices, and goods which use inputs from the agricultural sector, will feed into CPI and cause a rise in the index.

This is, of course, quite reasonable. Average households will find the cost of living is rising

The Guardian covers the story here

"Most people don't understand inflation"

The Office for National Statistics (ONS) are considering changing the way the Retail Price Index (RPI) is calculated.

The RPI and CPI don't provided the same figures for inflation as they have different baskets of good and are calculated in a different way.

This may not seem that important but government benefits, pensions and some investments are linked to one index or the other. When one is constantly higher than the other this means the gap between the various benefits and pensions widen.

Also some may say that the government wants the RPI to be lower so they can save money on those payments based on RPI.

So if the RPI is adjusted it may do some groups harm. Pensioners and pension funds among them.

The ONS are consulting on the need for change, but not many people are likely to respond. According to research very few people understand inflation let alone the complexities of how it is calculated. It may be that people with a lot to lose stay silent.

Rest assured I will be adding my voice to the consultation, but I'd like the use of geometric means in RPI which will cause the reported figure to fall a little.

The article on this raises important points and helps you to better understand how inflation is measured.

The BBC report the issue here

Inflation moderates, but head and tail winds continue

Inflation, as measured by the CPI, fell to 2.5% last month, that's down from 2.6%. This is still above the target rate of 2%, but it means inflation is going in the right direction.

There are always competing forces on the inflation rate. Some prices are rising and pushing the index up, others are falling and putting downward pressure on inflation. (Known as headwinds and tailwinds since a speech by the Governor of the Bank of England.)

Presently it is believed that inflation will fall towards target, despite factors such as higher food prices, because of weak demand in the economy generally. It is always difficult to be exact.

The BBC cover the figures here.

Look at the economy tracker for the data and maybe look at the personal inflation calculator

UK Unemployment

 UK CPI inflation

There is a well known relationship in Economics, called the Philips Curve. It states that there is a trade off between inflation and unemployment. As unemployment rises inflation subsides.

This relationship was solid until the mid 1970's but broke down in spectacular manner with rising unemployment and inflation appearing simultaneously. However many continue to look for this relationship in the data and the figures announced in the last two days will be seen as a return of the relationship.

Inflation has fallen sharply, so sharply that the Bank of England are worried about undershooting their 2% target. Unemployment edged up, less than feared, but it remains on an upward trend.

The causes of the rise in unemployment and fall in inflation are well known. But this is a perfect example to use when looking at the trade offs between the two variables. It makes it very difficult for governments to achieve their objectives in both.

Can you see the trade off in the data above?

BBC on inflation figures here

BBC on the unemployment figures here

Another chapter in the Euro crisis?

I am not sure if this is a new chapter or just another plot twist, the Euro saga has continued for so long its critical importance is sometimes forgotten.

The crisis deepens as Italy is now on the brink. Italy isn't like Greece or Ireland, it is a big economy with their government owing 120% of GDP to creditors. Italy is the third biggest economy in the Euro zone and even the enhanced €1 trillion bailout fund is nowhere near enough to save it if default comes.

Italy has no credible plan to resolve the problem and the market knows it. The market is demanding higher and higher interest rates (6.69% is the latest) to fund their overspending and the likelihood is that that rate will rise as Italy must borrow over €300bn next year.

There is a solution. Let the European Central Bank (ECB) lend the money to Italy. The ECB could buy Italian Government bonds and can theoretically supply all of Italy's needs. The Germans, at least, completely oppose this move.

If the ECB buys Italian debt they will do so with money they simply create. As with Quantitative Easing this raises the supply of Euro's in circulation (its printing money). The Germans always have in their minds the hyperinflation of the 1920's caused by printing money and the post-war Deutchmark which was managed so well that inflation was only an issue after the costs of unification with East Germany. They don't want the ECB to start a potentially inflationary process.

Most people disagree with the Germans. They see the need to save the Euro as far greater than the risk of inflation. They also point out that the Germans can only be right when the rate of rise in the money supply is faster than the rate of rise in real output. So far in this period of instability monetary growth has been sluggish and over the period 2009 - 10 the money supply would have fallen but for central bank action. The graphic at the top is a little small but shows M1 and M3 growth in the EU.

It is clear that if the ECB does not act and the Italian government does not change then the danger of a collapse in the Euro is imminent.

The Guardian has details here

Accuracy of inflation measures

Firstly I should declare an interest. This story affects my well-being in retirement and I'm not very happy about the pension changes currently proposed by the Government.

But the economics of this story, whether CPI or RPI should be used to annually adjust public sector pensions, is a relevant economic issue.

All price index's are compromises. They are based on the cost of a 'typical' basket of goods, discovered by a survey of consumer spending. However there are no 'typical consumers' the basket of goods is just an average. For some households the cost of living rises faster, for others slower.

The CPI was introduced when there were thoughts Britain might join the Euro (although it was never a serious option) and became the UK's 'official' measure of inflation. The CPI is more comparable with other EU countries measurement of inflation, but the British spend their money on slightly different things. So to construct the CPI the basket of goods had to be adjusted, reducing the impact of housing costs and including other items that did not actually affect UK residents.

The CPI is statistically more elegant. It reduces the effects of rouge price changes and deals with complex goods, such as the price of 'white bread' with its many varieties and easy substitution in a way that makes the RPI look clumsy, if not crude. But CPI will usually give a lower inflation rate than RPI (initially estimated at 0.5% it has actually been 0.75% since 2003).

The result of indexing pensions by CPI and not RPI will then lead to a 0.75% smaller rise in pensions each year and will save the Treasury £40bn in this parliament alone.

Actually neither CPI or RPI are the right measure to adjust pensions. A Pensioner Price Index should be used based on the typical basket of goods a pensioner household buys. For example fewer pensioners have mortgages and so both CPI and RPI overstate the effects of the housing market and mortgage rates on them. A Pensioner Index (PePI) is child's play to construct and indeed one already exists!

Of course the PePI may actually give smaller rises to pensioners!

The Guardian cover the story here

An expected Nobel Prize

Professors Tom Sargent and Chris Sims are the 2011 winners of the Nobel Prize for Economics. I was expecting it for years.

The important work for which they have received the prize is their contribution to modelling expectations. Prior to their work economists used a method known as 'adaptive expectations' to predict how households and firms would react to policy changes. This meant the computer models of the time used an equation that implied expectations moved slowly after a change in policy or events. Without being too technical this meant that policy changes could have big effects on behavior even though the policy was very predictable and mechanistic.

Sargent and Sims showed that expectations changed faster than previously thought and that by manipulating the expectations of firms and households policy, say to reduce inflation, would be much more effective. Many of you will have already looked at the importance of inflation expectations in the inflation process.

Today their work is very important in deciding macroeconomic policy, particularly in designing monetary policy. Take for example the debate on the pace of deficit reduction. Confidence is crucial in consumption and investment and based on their work it could be argued that more public spending and higher budget deficits will actually cause a worsening of confidence due to the effect it has on the expectations of households and firms.

The Nobel website has a Popular Information section, look at the 'Information for the Public' link and that allows you to download an excellent, non-technical,  summary of their work. (Pretty important for anyone considering Oxbridge/LSE/Warwick/Southampton/UCL economics.)

Nobel site link here

The Guardian coverage here

Inflation rises to 4.5%

Worse than expected inflation figures have surfaced this week putting increasing pressure on the Bank of England to increase interest rates. These are very tough times with many predicting unemployment figures to rise further. The only good news coming from the article is the hope of inflation figures dropping by the end of 2012. Read the article below.

http://www.bbc.co.uk/news/business-14895510

How tough is it going to get?

It is tough being British! Over the last 5 years energy prices have risen 76%, flour 89%, bread 50% and petrol prices 42% whilst real wages have fallen. While inflation presently remains high at 4.5% average wages rose just 2.3% (in the year up to March). This means a significant fall in the standard of living for many British people especially those low or fixed income earners. Please read the attached article from the Daily Mail.

http://www.dailymail.co.uk/news/article-1391434/11-million-British-workers-pay-flatline-2015-warns-think-tank-Resolution-Foundation.html