Basket Case

Enticing picture of coffee from the BBC’s story

In recent weeks we’ve covered inflation, and back at the start of the term discussed the importance of prices in determining all sorts of important economic variables, from national output (GDP) to most recently, the exchange rate.

Inflation is the rise in the general price level over some period of time. What is the general price level? This is determined via a “basket of goods”, supposedly what the average person buys and hence representative of prices the average person faces.

What is the “basket of goods”? The Office for National Statistics regularly updates the basket, which is reassuring, and the most recent updates were announced today: coffee pods are in, but nightclub fees are out. As a nation we are more in a hurry, making our real coffee via Nespresso machines and the like rather than the longer and more drawn out approach using a real coffee machine/pot, while we’re going to nightclubs less, apparently. What do you think?

Inflation is still Deflation

united-kingdom-inflation-cpiThis morning the latest inflation numbers have been released: -0.1%. That is, deflation. The Consumer Price Index, what the Bank of England uses to measure inflation, has barely changed since February – see above. To give some context, the Bank of England’s inflation forecasts since February have all suggested inflation would have risen back up to around 0.5% by now, yet persistently inflation is around zero.

Why does this matter? It matters on a number of levels; to mention a few:

  • Inflation is seen as a barometer of how well the economy is doing. Strong demand across the economy, given a fairly fixed supply, would yield inflation, and hence this suggests the economy is far from capacity (where supply would be fairly fixed).
  • Inflation is what the Bank of England must set its monetary policy to influence. The target is 2% with a 1% band either side, and hence inflation is below target. In this situation, the Bank might be expected to try and generate a bit of inflation to push back towards its target, yet interest rates, the tool the Bank uses, are already at their (effective) lower bound of 0.5%. It certainly doesn’t suggest the Bank is about to raise interest rates, another fear some have.
  • Inflation is the norm. Deflation has not been; I noted the one historical deflationary UK episode a few weeks ago. Japan has found itself fixed in zero/negative inflation territory for a long time now – it’s not the norm, and at least as far as Japan, and possibly increasingly the UK, are finding, it’s unexpectedly persistent too.

We’ll spend time looking at inflation next term…

School Trip to the Bank of England

Yesterday a group of us from the economics department went to the Bank of England in London. We spent time in the Bank of England Museum before having a talk about the history of the museum, bank notes and gold.

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The museum is a number of things, but perhaps most obviously it’s a museum of economics; in the main hall there’s a number of displays talking about the monetary system; definitions of inflation, for example:

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It’s hugely important to have quick and easy definitions for terms like inflation, money, and quantitative easing. If nothing else, you can at least prove your friends wrong when they make grand assertions about economic matters.

The opening hall is full of exhibits that make the point that monetary policymaking is hard work:

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Here, you can pull up and down the lever on the right to affect where the ball is, between deflation and inflation of 10%+. The problem is that on the left there’s an “economic shock” which makes it very hard to ever get the ball to 2%. Not too dissimilar to the outcomes of actual inflation over recent years…

What is an economic shock? Another exhibit had genuine BBC news footage from throughout recent decades from events such as the oil crises in the 1970s, the stock market crash of 1987 and the UK’s exit from ERM in 1992 – all huge events that had considerable impacts on wider economic activity.

Perhaps the most exciting exhibit is a bar of gold – value close on £300,000! As you can see, high security:

gold-selfie

 

The talk we had talked through the history of a state bank and central bank and how it developed, along with the development of bank notes from bits of paper to the soon-to-be plastic £5, £10, £20 and £50 notes we now use.

All in all, a fascinating museum, educational and good fun at the same time. If you are in London and within easy reach of the Bank, I’d highly recommend getting along – it’s free!

 

Negative Inflation

More economic news this morning: inflation has gone negative. What does this mean?

It means that the UK’s Consumer Price Index (CPI), a collection of prices of goods the “average consumer” will buy, has fallen over the last year, since September 2014. As the BBC point out, the ONS (Office for National Statistics, who collect and publish the CPI) attribute this fall to smaller than normal increases in the prices of clothing, and falls in petrol prices: two goods we tend to buy quite often. Perhaps also importantly: clothes and oil, by and large, are not produced in the UK and are things we import.

Here’s UK inflation since 1955:

Negative inflation is incredibly rare: a short spell around 1960, and the current spell.

What does this all mean? Possibly quite little; the UK exited the 1960 deflation (negative inflation) spell quite quickly. However, inflation is generally associated with a growing economy: growing aggregate demand and an aggregate supply unable to keep pace. If this is so, then it suggests the current economic recovery is weaker than perhaps we might think. On the other hand, if the primary reasons for negative inflation are from abroad, then this is arguably good news: the economy (hence our incomes) is growing, and prices aren’t rising – this should mean we all feel that bit better off, since we have more money to spend on things.

Bank of England keeps interest rates on hold

On the first Thursday of the month (or the second, it seems, if the first is the 1st), the Bank of England’s Monetary Policy Committee meets to decide on monetary policy in the UK. At midday on that Thursday, they announce what they have decided to do; it’s just been announced that interest rates will remain at 0.5%, where they have been now for over five years. Here’s the entire history of the Bank of England “base rate”, which is the rate it sets monthly:

You’ll note that the rate reached 0.5% before 2011 (right at the end of the chart), and it’s still there. It’s one of the longest spells without a change for decades.

The MPC is a group of economists, both ones that work for the Bank of England, and a group of external members, often university professors and economists that work in the private sector. The idea is that they apply a wide range of expertise and experience on the UK economy to policymaking decisions. They are trying to hit a target of 2% inflation, that the UK government sets for them, but at the moment inflation is around 0, hence below target.

Prior to this, inflation spent a number of years above target, and perhaps as a result, there have been a number who have called openly for a rethink about the Bank of England’s role in policymaking, not least the new Labour Shadow Chancellor of the Exchequer.

We’ll consider monetary policy in about week 8 or 9 next term, once we’ve considered the various constituent parts of what the MPC thinks about when making decisions: inflation, growth, consumption, investment, money, interest rates and banking.