Letter writing has, in many walks of life, rather gone out of fashion. For instance, many of us of a slightly older disposition remember how putting pen to paper was an important part of courtship and the building of relationships. Well, one modern-day couple who are getting very used to an exchange of letters is the Governor of the Bank of England and the Chancellor of the Exchequer. The latest inflation numbers from the Office for National Statistics show that the annual rate of CPI inflation for July was 3.1%. While the inflation rate is down from the 3.2% recorded in June it remains more than 1 percentage point above the government’s central inflation rate target of 2%. Consequently, Mervyn King will again be writing to the Chancellor to explain why this is the case.
Since the turn of the year, the annual rate of CPI inflation has, with the exception of February, been consistently above 3%. Even February was a narrow escape for the Governor because inflation came in at exactly 3%! Another way of putting the recent inflation record into perspective is to note that over the first seven months of 2010 the average annual rate of CPI inflation has been 3.3%.
The slight fall in July’s annual inflation rate is attributed, in part, to falls during July in the prices of second-hand cars and petrol whereas these prices were rising a year ago. Furthermore, the average price of clothing and footwear fell by some 4.9% between June and July of this year as compared with a fall of 3.2% in the same period a year ago. The result is that the annual rate of price deflation for clothing and footwear went from 1.4% in June to 3.1% in July.
Of course, within the basket of consumer goods price patterns can vary significantly. One significant upward pressure on July’s overall annual inflation rate was the price of food and non-alcoholic beverages, especially vegetables. The average price of food and non-alcoholic beverages rose by 1% between June and July which has seen the annual rate of price inflation for food and non-alcoholic beverages rise from 1.9% in June to 3.4% in July.
The fact that July shows inflation running in excess of 3% will surprise very few. In the latest Inflation Report the Bank of England reports that the Monetary Policy Committee’s view is that ‘the forthcoming increase in VAT was expected to keep CPI inflation above the 2% target until the end of 2011’. The Committee then expects what it describes as a ‘persistent margin of spare capacity’ to force inflation to fall back. But, the Committee also feels that the prospects for inflation are ‘highly uncertain’. Therefore, it is difficult to gauge just how many more letters will be passing across London between the Governor and the Chancellor in the coming months. Nonetheless, it would be probably be advisable for the Governor to make sure that he has a sufficient supply of postage stamps at his disposal, just in case!
Articles
UK inflation rate slows again in July BBC News (17/8/10)
Bank of England’s King forced to write another letter to Osborne as prices stay high Telegraph (17/8/10)
Inflation falls to 3.1% in July Financial Times, Daniel Pimlott (17/8/10)
Dearer food keeps inflation high UK Press Association (17/8/10)
Bank ‘surprised’ at inflation strength Independent, Russell Lynch (17/8/10)
Letters
Letter from the Governor to the Chancellor and the Chancellor’s reply Bank of England (17/8/10)
Data
Latest on inflation Office for National Statistics (17/8/10)
Consumer Price Indices, Statistical Bulletin, July 2010 Office for National Statistics (17/8/10)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank
Questions
- What does the Bank of England mean by a ‘persistent margin of spare capacity’? By what economic term is this phenomenon more commonly known?
- Why do you think the current rate of inflation is above target despite the spare capacity in the economy?
- Since the annual rate of CPI inflation remains in ‘letter-writing territory’ would you expect the Monetary Policy Committee to be raising interest rates some time soon? Explain your answer.
- What impact might the persistence of above-target inflation have for the public’s expectations of inflation?
- What impact can we expect the increase in the standard rate of VAT next January to have on the annual rate of CPI inflation? Is such an effect on the rate of inflation a permanent one?
The US economic recovery is slowing. As consumer and business confidence wanes, so there is growing talk of a double-dip recession. So what’s to be done about it? How can aggregate demand be boosted without spooking the markets?
One solution would be for a further fiscal stimulus. The one instituted in January 2009 in the depth of the recession has virtually worked itself out, with many short-term projects financed by the stimulus having come to an end. But any further stimulus would cause further worries about America’s balooning public-sector deficit, which already is predicted to be some 10.6% for 2010 (up from 1.1% in 2007).
The alternative is to use monetary policy. But, with the Federal Reserve rate already at between 0% and 0.25% (where it has been since the end of 2008), there is no scope for further cuts in interest rates. If monetary policy is to be used to give an additional boost to the economy, then further quantitiative easing is necessary. This is what the Federal Reserve decided to do on 10 August. As the Independent (see link below) states:
The US Federal Reserve decided last night to extend its $1.55 trillion programme of quantitative easing in an attempt to rejuvenate an economic recovery that the central bank admitted was turning out “more modest” than it expected.
The interest rate-setting Federal Open Market Committee bowed to calls from across the financial markets to extend its support, saying it would pump new money into the markets at a rate equivalent to about $200bn a year, and it left the duration of its efforts open-ended.
So how successful is this policy likely to be? The following articles look at the issues.
Articles
‘Light’ quantitative easing for slow US economic recovery New Statesman (11/8/10)
Fed sets the printing press rolling again to juice recovery Independent, Stephen Foley (11/8/10)
US Federal Reserve reveals plan to buy government debt Herald Scotland, Douglas Hamilton (11/8/10)
Some questions and answers on the Fed`s new policy Money Control (11/8/10)
Fed downgrades recovery outlook Financial Times, James Politi and Michael Mackenzie (10/8/10)
Fed acts as US recovery loses steam ABC News, Peter Ryan (11/8/10)
Top Fed Official, Warns Fed Risks Repeating Past Mistakes Huffington Post, Thomas Hoenig (11/8/10)
Austerity or stimulus? Some economists ha
The Fed must address Main Street’s credit crunch The Economist, Guillermo Calvo (15/8/10)
The Fed has options to lower real interest rates The Economist, Mark Thoma (15/8/10)
Fear of renewed recession in America is overblown; so is some of the optimism in the euro area The Economist (12/8/10)
Analysts’ view: Economists divided on effectiveness of Fed move Reuters (11/8/10)
If the Fed’s going to monetise debt, now’s the time to do it The Economist, Laurence Kotlikoff (13/8/10)
A former Fed official offers advice to Ben Bernanke The Economist, Joseph Gagnon (17/8/10)
America’s century is over, but it will fight on Guardian, Larry Elliott (23/8/10)
Federal Reserve documents
Press Release on monetary policy Federal Reserve (10/8/10)
Information on Federal Open Market Committee Federal Reserve
Questions
- What are are the arguments for using quantitative easing?
- Explain the process by which quantitative easing increases (a) narrow money and (b) broad money.
- How has the US and global economic situation changed since June 2010?
- Could the Fed’s policy be described as one of quantitative easing or merely one of maintaining the existing quantity of money? Explain.
- What are dangers in pursuing a policy of quantitative easing?
- What are the arguments for pursuing tight fiscal policy at the same time as loose monetary policy?
- Why does Thomas Hoenig claim that the Fed risks repeating past mistakes?
- How could the real rate of interest be reduced if the nominal rate is virtually zero and cannot be negative?
- Explain what is meant by ‘seigniorage’ (see the final The Economist article above).
Every three months, the Bank of England produces its Inflation Report. This includes forecasts for inflation and economic growth for the next three years. The forecasts are presented as fan charts. These depict the probability of various outcomes for inflation or growth in the future. “In any particular quarter of the forecast period, GDP is expected to lie somewhere within the fan on 90 out of 100 occasions.” Each coloured band represents a 10% probability of occurrence. “Although not every member will agree with every assumption on which our projections are based, the fan charts represent the MPC’s best collective judgement about the most likely paths for inflation and output, and the uncertainties surrounding those central projections.” The broader the fan the less confident are the forecasts. The fans have tended to get broader in recent Reports, reflecting the greater uncertainties in the UK and global economies since the credit crunch.
Since the last Report, the forecast for economic growth in 2011 has been adjusted downwards from 3.4% to 2.5%. Inflation, while still being forecast to be below the target of 2% in two years’ time, is forecast to rise in the short term, thanks to higher commodity prices and the rise in VAT from 17.5% to 20% in January 2011.
So what impact, according to the Report, will various factors such as the Coalition’s emergency Budget in June, rising commodity prices, falling consumer confidence and improving export performance have on the economy? And how much credence should be put on the forecasts? The following articles address these questions
Articles
Bank chief warns of ‘choppy recovery’ Independent, Russell Lynch (11/8/10)
King warns of ‘choppy recovery’ for economy Channel 4 News, Faisal Islam (11/8/10)
Bank of England warns UK recovery will be weaker than hoped Telegraph (11/8/10)
Bank of England lowers UK growth forecast Telegraph, Angela Monaghan (11/8/10)
Bank of England cuts UK economic growth forecasts Guardian, Katie Allen (11/8/10)
Bank of England forecasts ‘choppy’ economic recovery BBC News, Katie Allen (11/8/10)
Bank of England Cuts Outlook for Economic Growth Bloomberg, Jennifer Ryan (11/8/10)
Why is the UK heading into choppy waters? BBC News Analysis, Hugh Pym (11/8/10)
Bank of England overhauls forecast model after errors Telegraph, Philip Aldrick (11/8/10)
The Bank’s impossible balancing act Independent, David Prosser (11/8/10)
How uncertain exactly is the uncertain BoE? Reuters Blogs, MacroScope (11/8/10)
‘Slowflation’ – the combination the Bank of England fears most Independent, Sean O’Grady (11/8/10)
The Bank is right to paint a mixed picture Independent, Hamish McRae (11/8/10)
Sterling falls, gilts rally after Bank of England cuts growth forecasts Guardian Blogs, Elena Moya (11/8/10)
Report
Inflation Report
Inflation Report Press Conference
Questions
- Do the Bank of England’s forecasts suggest that the UK economy is on track for meeting the inflation target in 24 months’ time?
- How much reliance should be put on Bank of England inflation and growth forecasts? You might want to check out the forecasts made one and two years ago for current (2010) rates of inflation and growth (see Inflation Reports (by date)).
- What are the factors that have persuaded the Bank of England to reduce its forecast for the rate of economic growth in 2011? Are these factors all on the demand side?
- According to the fan chart for economic growth, what is the probability that the UK economy will move back into recession in 2011?
- Will the rise in VAT in January 2011 cause inflation to be higher in 2012 than in 2010 (other things being equal)? Explain.
- Why did the FTSE fall by 2.4% on the day the Report was released?
- If commodity price inflation increases (see Food prices: a question of supply and demand), what impact is this likely to have (a) on the rate of economic growth; (b) on the rate of interest chosen by the MPC?
- What policy should the Bank of England adopt to tackle ‘slowflation’?
UK unemployment now stands at 2.47 million, which is a fall of 34,000 people in the three months to May. Meanwhile, the claimant count, which measures the number of individuals claiming Jobseeker’s Allowance, fell by 20,800 between May and June to stand at 1.46 million.
The total number in employment increased by some 160,000 in the three months to May to reach 28.98 million. The increase in the number of individuals in work is largely due to an increase in the number of part-time workers, which now stands at some 27%. The development of the flexible firm has played a huge role in creating more and more part-time jobs.
Although declining unemployment is good news, and the jobless rate of 7.8% is now comparable with the EU and the US, there are suggestions that it may rise again next year. Indeed, unemployment is expected to peak at nearly 3 million in 2012 (10%) and an employer’s group has said that the UK may face serious job deficits for the next decade. As more and more jobs are lost in the public sector, estimates suggest that the economy must grow by 2.5% per year from now until 2015, in order to compensate these losses with extra jobs in the private sector.
As John Philpott, the Chief Economic Adviser at the CIPD said:
“A slightly milder growth outcome – which many would consider a decent recovery in output given the various strong headwinds at present facing the economy – is easily as imaginable as the OBR’s central forecast and would leave unemployment still close to 2.5 million by 2015, meaning Britain faces at least half a decade of serious prolonged jobs deficit.”
So, although the fall in the jobless rate is undoubtedly good news, the uncertain future for unemployment in the UK, will put a slight dampener on this news.
Articles
UK unemployment declines to 2.47m BBC News (14/7/10)
Economy Tracker BBC News (14/7/10)
Unemployment to peak at 3m by 2012 Telegraph (14/7/10)
Labour market report to show outlook for jobs worse than OBR projections Guardian, Katie Allen (14/7/10)
Part-time work boosts UK employment rate Sky News, Hazel Tyldesley (14/7/10)
Unemployment figures: what the experts say Guardian, Katie Allen (14/7/10)
Data
Labour market statistics latest: Employment ONS
Labour Market Statistical Bulletin – July 2010 ONS
Labour market statistics: portal page ONS
Questions
- How is unemployment measured in the UK? Which is the most accurate method?
- What is the flexible firm and how has it allowed more part-time jobs to be created?
- Why is unemployment expected to rise again in the next few years?
- The ONS has reported that wage growth has eased sharply. How will this, along with falling unemployment rates, affect household incomes and consumption? Will one effect offset the other?
- Brendan Barber in the Guardian article, ‘Unemployment figures – what the experts say’, wrote that unemployment lags behind the rest of the economy. Why is this?
- What type of unemployment are we experiencing in the UK? Illustrate this on a diagram.
- Consider the government’s plans in terms of spending cuts. How are they likely to affect the rate of unemployment in the UK?
The sun may have been shining of late across the UK, but there are increasing signs that economic sentiment is deteriorating, more especially amongst consumers. The EU’s economic sentiment index for the UK fell for the first time since November of last year and is now just a little below its long-run average.
The EU’s economic sentiment index is a composite indicator of confidence in that it captures confidence levels amongst both consumers and businesses. While overall sentiment actually increased in each month from December of last year through to this May, the decline in consumer confidence in the UK is now well established having fallen each month since March.
We might expect the falls in consumer confidence to be reflecting the prevailing economic environment and, in particular, the increasing number of people unemployed. However, since the sentiment survey contains forward-looking questions too, it may be that declining consumer sentiment reflects concerns amongst households about the impact of fiscal consolidation measures. These consumer expectations could be important in affecting consumer behaviour today. It could be very important to track consumer confidence in the coming months, especially in light of the measures announced in the Budget of 22 June (which occurred after June’s polling of consumers) and subsequent announcements too.
Interestingly, declining levels of consumer confidence in the UK had until June been offset by rising confidence amongst businesses. However, confidence across most sectors of industry deteriorated in June. In particular, confidence amongst manufacturers fell back very sharply. Bucking the trend were businesses in the service sector who reported feeling more confident than at any time since March 2008. However, given waning sentiment elsewhere, one would expect this to be relatively short-lived.
The profile of the average economic sentiment indicator across all 27 member states of the EU is broadly similar to that for the UK. It exhibits a sharp and continuous rise from the historic lows of the indicator recorded in March 2009, but fell back, although very slightly, in June. The improvement in sentiment amongst business has been especially marked. Sentiment too had been improving amongst consumers, but recent evidence points to consumer confidence easing, although not quite to the extent seen here in the UK.
There are, of course, some notable national trends in sentiment across EU countries. It will come as little surprise to know that in Greece the economic sentiment indicator has, in recent months, been at historic lows. If you are looking for countries where sentiment is above average, then perhaps try, amongst others, Austria, Denmark, Finland and Germany!
Articles
Euro economic sentiment near-static RTE (29/6/10)
Eurozone confidence unchanged Bloomberg Business Week, Associated Press (29/6/10)
Eurozone economic sentiment picks up Financial Times, Stanley Pignal (29/6/10)
FTSE loses more than 3% as Wall Street slides on confidence data Guardian (Market Forces Blog) (29/6/10)
How long can the housing market avoid a crash? Independent, Sean O’Grady (30/6/10) (Article stresses link between confidence and the housing market)
Data
Business and Consumer Surveys The Directorate General for Economics and Financial Affairs, European Commission
Consumer Confidence Nationwide Building Society
Questions
- Think about your confidence in your own financial situation. Draw up a list of those factors that might affect this confidence. How might this list change if you were thinking about the level of confidence across all consumers?
- Why might confidence amongst UK consumers have been falling well before that amongst businesses? Do you think such divergences can persist for any length of time?
- What factors do you think might be particularly important in affecting the sentiment amongst consumers and businesses in the weeks and months ahead?
- Imagine that you are given a choice of plotting a chart over time of the economic sentiment indicator and either the level of real GDP or the rate of growth in real GDP. Which plot would you go for and why?
- Perhaps the key question of all! Do you think economists can learn anything from tracking the patterns in economic sentiment?