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?
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?
For some, thoughts will have turned to events on football pitches in South Africa. Perhaps though we should spare a thought for the Governor of the Bank of England, Mervyn King, who is likely to be concerned by his own team’s recent performance in missing the inflation rate target! Mervyn’s resulting ‘yellow card’ involves writing a letter to the Chancellor of the Exchequer every time the annual rate of CPI (Consumer Price Index) inflation deviates by more than one percentage point from the government’s central target of 2%. Unfortunately for the Governor, since the turn of the year, only in February has the annual rate of CPI inflation failed to exceed 3%. And, even that was within in a whisker of missing the goal since the rate of inflation squeaked in at 3%. Perhaps February was more a case of hitting the post!
As all sports fans know, a run of disappointing results can lead to dissent amongst players and supporters alike. We can see from the minutes of June’s meeting of the Monetary Policy Committee the extent of the debate over the persistence of inflation. The debate included discussions concerning the impact of the expected fiscal consolidation measures (the MPC met before the Budget), the public’s higher inflation rate expectations, the price of oil and other commodities and the margin of spare capacity in the economy (the output gap). The minutes reveal that one member of the MPC, Andrew Sentance, voted for an increase in interest rates believing that inflation had been particularly resilient in the aftermath of the recession.
We now have new forecaster in town: The Office of Budget Responsibility. In our blog article Who’d be a forecaster? A taxing time for the new OBR we looked at the growth forecasts produced by the Office of Budget Responsibility taking into account the Budget Measures of 22 June. The June 2010 OBR Budget forecasts also contain predictions for CPI inflation. So what do the OBR say?
The OBR predicts that the annual rate of CPI inflation will stay around 3% in the near term. It is now slightly more pessimistic about the prospects for inflation beyond the near term than it was in its pre-Budget forecasts. More specifically, it says that CPI inflation will ‘decline more gradually’ than first thought because of the rise in the standard rate of VAT to 20% in January 2001 and its belief that oil prices will be higher than originally envisaged. The OBR is forecasting the average price of a barrel of oil in 2010/11 to be $78 rising to $82 in 2011/12.
Going further ahead, the OBR expects the rate of inflation to fall back to ‘a little under 2 per cent in early 2012’. It argues that this will reflect the unwinding of the VAT effect, and, significantly, the downward pressure on prices from the larger negative output gap that will result from the fiscal consolidation measures in the Budget. In other words, the expectation is that there will be greater slack or spare capacity in the economy which will help to subdue price pressures.
If the OBR is right, the Governor may have more letter-writing to do in the near term and perhaps well into 2011. But, the fiscal consolidation measures should, once the impact of the VAT rise on the inflation figures ‘drops out’, see the rate of inflation fall back. Perhaps then, the final whistle can be blown on the Governor’s inflation troubles. In the mean time it will be interesting to see how MPC members take on board, in their deliberations over interest rates, the Budget measures and the OBR’s own thoughts on inflation. Could interest rates be rising shortly despite fiscal consolidation? Let Mervyn and his team play on!
OBR Forecasts
Budget Forecast June 2010 OBR (22/6/10)
Pre-Budget Forecast June 2010 OBR (14/6/10)
Monetary Policy Committee
Overview of the Monetary Policy Committee
Monetary Policy Committee Minutes
Inflation Data
Latest on inflation Office for National Statistics (15/6/10)
Consumer Price Indices, Statistical Bulletin, May 2010 Office for National Statistics (15/6/10)
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
Articles
MPC minutes reveal Bank split on inflation risk Financial Times, Daniel Pimlott (23/6/10)
Bank of England minutes reveal surprise split on interest rates Guardian, Katie Allen (23/6/10)
Instant view: Bank split 7-1 on June vote Reuters UK (23/6/10)
Now even the Bank isn’t sure it can bring down inflation Independent, Sean O’Grady (24/6/10)
An inflation hawk hovers over the Bank of England Guardian, Nils Pratley (24/6/10)
Questions
- Explain why an output gap – the amount of spare capacity in the economy – might impact on price pressures.
- What impact would you expect the rise in the standard rate of VAT next January to have on the CPI (price level) and on the CPI inflation rate? What about the following year?
- Some economists believe that by being more aggressive in cutting the fiscal deficit, interest rates will be lower than they otherwise would have been. Evaluate this argument.
- Now for your turn to be a member of the MPC and to decide on interest rates! How would you vote next month? Are you a ‘dove’ or a ‘hawk’?
The latest ONS labour market release reveals that in the three months to April the number of people unemployed in the UK was 2.472 million, up by 23,000 on the previous three months (i.e. the three months to January). The rate of unemployment – the number of people unemployed expressed as a percentage of those economically active – nudged upwards to 7.9% from 7.8% in the previous three months.
In a previous article A labour challenge for Osborne we considered the possibility that some of the emerging patterns in the labour market numbers could act as an impediment on the future potential output of the UK economy. The latest figures seem to offer little obvious comfort in this respect. Here, we note three causes for possible concern.
Firstly, we note the continued rise in inactivity. Of those of working age, inactivity rose by a further 29,000 in three months to April to stand at 8.186 million. This is an historic high and equates to 21.5% of the potential working population.
Secondly, we note the continued rise in long-term unemployment. The number of people unemployed for more than one year rose by 85,000 in the three months to April to stand at 772,000. This compares with 399,000 in the same three month period in 2007, just as the first clear signs of the impending financial crisis were being drawn to the public’s attention. In other words, this measure of long-term unemployment has effectively doubled since the financial crisis. But, more than this, 31.2% of those unemployed have been so for at least one year.
Thirdly, we note the high levels of youth unemployment. In the three months to April the number of unemployed people aged 18-24 was 713,000. This was down on the previous three months, but by a mere 2,000. The unemployment rate amongst 18-24 year-olds is 17.3% which is more than double the overall unemployment rate of 7.9%.
Aside from the very obvious personal costs of unemployment and of inactivity, each of these labour market issues poses important economic challenges for the country and its policy-makers. These are difficult challenges at the best of times. But, they could hardly be more difficult given the current national and international economic environment and, of course, the tendency for fiscal consolidation both at home and abroad.
Articles
Unemployment: public sector feels the pain as jobless hits 2.47 million Telegraph, Harry Wallop (16/6/10)
Unemployment: what the experts say Guardian (16/6/10)
Unemployment rises as public sector shrinks Financial Times, Brian Groom (16/5/10)
UK unemployment rises to 2.47 million BBC News (16/6/10)
Unemployment levels a ‘challenge’ for government: Interview with Work and Pensions minister, Chris Grayling BBC News (16/6/10)
Data
Latest on employment and unemployment Office for National Statistics (16/6/10)
Labour Market Statistics, June 2010 Office for National Statistics (16/6/10)
Labour market statistics portal Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- Evaluate the possible consequences for the UK economy, both now and in the future, of: (i) high and rising levels of inactivity; (ii) high and rising levels of long-term unemployment; and (iii) high levels of youth unemployment.
- Again, thinking about the issues of labour market activity, the duration of unemployment and youth unemployment, what policy recommendations would you make in trying to tackle them?
- If you were writing this blog in a year’s time, what would you expect will have happened to levels or rates of inactivity, long-term unemployment and youth unemployment? Explain your answer.
- Again, if you were writing this blog in a year’s time, would you expect to find any other emerging patterns in labour market statistics? Explain your answer.
In the UK, we have an inflation target of 2% and it’s the Bank of England’s job to use monetary policy, in particular interest rates, to keep inflation within 1 percentage point of its target. However, with rising commodity prices and the onset of recession back in 2008, interest rates had another objective: to prevent or at least lessen the recession. Bank Rate fell to 0.5% and there it has remained in a bid to encourage investment, discourage saving and increase consumption, as a means of stimulating the economy.
However, at such a low rate, interest rates are not acting as a brake on inflation, which is now well above target. This rise in inflation, has been largely brought about by cost-push factors, such as the restoration of the 17.5% VAT (up from the temporary 15%), higher oil and commodity prices, and a fall in the exchange rate. But part of the reason might be found in the increase in money supply that resulted from quantitative easing.
There are concerns that the UK may lose its credibility on inflation if action isn’t taken. The OECD has advised the Bank of England to raise Bank Rate to 3.5% by the end of 2011. The following articles consider this issue.
Articles
Time to worry about inflation? BBC News blogs, Stephanomics, Stephanie Flanders (28/5/10)
UK must not fall for the false promise of higher inflation Telegraph, Charles Bean, Deputy Governor of the Bank of England (4/6/10)
Reports and documents
General Assessment of the Macroeconomic Situation OECD Economic Outlook, No. 87 Chapter 1 (see especially pages 53–4) (May 2010)
United Kingdom – Country Summary OECD Economic Outlook, No. 87 (May 2010)
Statistical Annex OECD Economic Outlook, No. 87 (available 10/6/10)
Inflation Report portal Bank of England (see May 2010)
Questions
- Explain the relationship between interest rates and inflation. Why have such low interest rates caused inflation to increase?
- In 2008, the UK moved into recession, but was also suffering from inflation. This was unusual, as AD/AS analysis suggests that when aggregate demand falls, growth will fall, but so will prices. What can explain the low growth and inflation we saw in 2008?
- What is the difference between real and nominal GDP?
- What are the causes of the current high inflation and what solutions are available and viable?
- Why are expectations of inflation so important and how might they influence the Bank of England’s plans for interest rates?
- Do you think the OECD should have advised the Bank of England? Will there be any adverse effects internationally if the UK doesn’t heed the OECD’s advice?
- Is the OECD’s assessment of the UK in the above Country Summary consistent with its view on UK interest rates contained in pages 53 and 54 in the first OECD link?