The CPI index fell by 0.1% in the 12 months to April 2015. This is partly the result of lower air and sea fares, as the upward ‘blip’ in these fares at Easter last year was not present in mid-April this year as Easter fell outside the period when the statistics are collected. What is more significant is that fuel, commodity and retail food prices have fallen over the past 12 months, and the exchange rate has risen, especially against the euro.
But how do we define what’s happened and how significant is it? It might seem highly significant as it’s the first time in 55 years that the CPI has fallen over a 12-month period. In fact, the effect is likely to be temporary, as fuel prices are now rising again and commodity prices generally are beginning to rise too. What is more, the pound seems to have peaked against the euro. Thus although aggregate demand remains relatively dampened, the main causes of falling prices and potential rises in the coming months are largely to be found on the cost side. This then brings us on to the definition of a falling CPI.
A falling CPI over a 12-month period can be defined as negative inflation. This is unambiguous. But is this ‘deflation’? The problem with the term ‘deflation’ is that it is ambiguous. On the one hand it can be defined simply as negative inflation. In that case, by definition, the UK has experienced deflation. But on the other, it is used to describe a situation of persistent falling prices as a result of declining aggregate demand.
If an economy suffers from deflation in this second sense, the problem can be very serious. Persistent falling prices are likely to discourage consumers from spending on durables (such as fridges, TVs, cars and furniture) and firms from buying capital equipment. After all, why buy an item now if, by waiting, you can get it cheaper later on? This mentality of waiting to spend leads to falling aggregate demand and hence falling output. It also leads to even lower prices. In other words deflation can get worse: a deflationary spiral.
If we define deflation in this second, much more serious sense, then the UK is not suffering deflation – merely temporary negative inflation. In fact, with prices now falling (slightly) and wages rising at around 2% per year, there should be an increase in aggregate demand, which will help to drive the recovery.
Videos
Should Britain Panic Over Negative Inflation? Sky News, Ed Conway (20/5/15)
UK inflation negative for first time since 1960; BoE says temporary Reuters, Andy Bruce and William Schomberg (19/5/15)
UK inflation negative for the first time since 1960 CNBC, Dhara Ranasinghe (19/5/15)
Articles
UK inflation rate turns negative BBC News (19/5/15)
Why there’s little to fear as the spectre of deflation descends on UK The Telegraph, Szu Ping Chan (19/5/15)
UK inflation turns negative The Guardian, Katie Allen (19/5/15)
Is the UK in the early stages of deflation? The Guardian, Larry Elliott (19/5/15)
Is the UK in deflation or negative inflation? Q&A The Guardian, Katie Allen and Patrick Collinson (19/5/15)
Market View: Economists unconcerned on temporary deflation FT Adviser, Peter Walker (19/5/15)
Questions
- Is negative inflation ever a ‘bad thing’?
- Explain the movement in UK inflation rates over the past five years.
- How do changes in exchange rates impact on (a) inflation; (b) aggregate demand? Does it depend on what caused the changes in exchange rates in the first place?
- Why is the current period of negative inflation likely to be short-lived?
- Would you describe the negative inflation as negative cost-push inflation?
- What factors could change that might make negative inflation more persistent and raise the spectre of deflation (in its bad sense)?
- If inflation remains persistently below 2%, what can the Bank of England do, given current interest rates, to bring inflation back to the 2% target?
- What is meant by ‘core inflation’ and what has been happening to it in recent months?
- What global factors are likely to have (a) an upward; (b) a downward effect on UK inflation?
Interest rates are the main tool of monetary policy and crucially affect investment. There has been much discussion since the end of the financial crisis concerning when UK interest rates would eventually rise. Uncertainty over just when, and by how much, interest rates will rise affects business confidence and hence investment. Businesses therefore listen carefully to what the Bank of England says about future movements in Bank Rate. But Mark Carney has now spoken about another cause of uncertainty and its impct on investment. This is the uncertainty over the outcome of the referendum on whether the UK should leave the EU.
By 2017, the Prime Minister has promised a referendum on staying in the EU, but Mark Carney has urged for this to be held ‘as soon as possible’. Whether or not the UK remains in the EU will have a big effect on businesses and with the uncertainty surrounding the UK’s future, this may soon turn to a lack of investment. 
As yet, businesses have not responded to this uncertainty, but the longer the delay for the referendum, the more inclined firms will be to postpone investment. As Mark Carney said:
“We talk to a lot of bosses and there has been an awareness of some of this political uncertainty – whether because of the election or because of the referendum … What they’ve been telling us, and we see it in the statistics, is they have not yet acted on that uncertainty – or to put it another way, they are continuing to invest, they are continuing to hire.”
Leaving the EU will have big effects on consumers and businesses, given that the EU is the UK’s largest market, trading partner and investor. With a referendum sooner rather than later, uncertainty will be more limited and any reaction by businesses will take place over a shorter time period. There are many other factors that affect business investment, some of which are related to the UK’s relationship with the EU and the following articles consider these issues.
EU referendum should be held ‘as soon as necessary’, says Mark Carney BBC News (14/5/15)
Business want an early EU referendum, Mark Carney indicates The Telegraph, Ben Riley-Smith (14/5/15)
EU poll should take place ‘as soon as necessary’, says Bank of England Chief The Guardian, Angela Monaghan (14/5/15)
Threat of business leaving the EU is fuelling business ‘uncertainty’, says Bank of England governor Mark Carney Mail Online, Matt Chorley (14/5/15)
Bank of England’s Mark Carney urges speedy EU referendum Financial Times, George Parker (14/5/15)
Questions
- Why is the EU important to the UK’s economic performance?
- If the UK were to leave the EU, what impact would this have on UK consumers?
- What would be the impact on UK firms if the UK were to leave the EU?
- Consider an AD/AS diagram and use this to explain the potential impact on the macroeconomic variables if the UK were to leave the EU.
- Why is uncertainty over the UK’s referendum likely to have an adverse effect on investment?
Insolvencies in England and Wales have fallen to their lowest level since 2005, official records show. The Insolvency Service indicates that bankruptcy, individual voluntary arrangements and debt relief orders have fallen, with the largest and worst form of bankruptcy falling by 22.5 per cent compared to the same period in 2014. There has also been a fall in corporate insolvencies back to pre-crisis levels.
The British economy is recovering and despite an increase in consumer borrowing of £1.2 billion from February to March, which is the biggest since the onset of the credit crunch, the number of people in financial difficulty and living beyond their means has fallen. However, there are also suggestions that the number could begin to creep up in the future and we are still seeing a divide between the north and south of England in terms of the number of insolvencies.
There are many factors that could explain such a decline in insolvencies. Perhaps it is the growth in wages, in part due the recovery of the economy, which has enabled more people to forgo borrowing or enabled them to repay any loan more comfortably. Lower inflation has helped to reduce the cost of living, thereby increasing the available income to repay any loans. Interest rates have also remained low, thus cutting the cost of borrowing and the repayments due.
But, another factor may simply be that lending is now more closely regulated. Prior to the financial crisis, huge amounts of money were being lent out, often to those who had no chance of making the repayments. More stringent affordability checks by lenders may have a large part to play in reducing the number of insolvencies. President of R3, the insolvency practitioner body, Phillip Sykes said:
“It may be too early to draw conclusions but demand could be falling as a result of low interest rates, low inflation and tighter regulation. This trend is worth watching.”
Mark Sands, from Baker Tilly added to this, noting that fewer people were now in financial difficulty.
“As well as this, we are seeing lower levels of personal debt and fewer people borrowing outside of their means due to more stringent affordability checks by creditors.”
Whatever the main reason behind the data, it is certainly a positive indicator, perhaps of economic recovery, or that at least some have learned the lessons of the financial crisis. The following articles consider this topic.
Personal insolvencies fall to 10-year low Financial Times, James Pickford (1/5/15)
Personal insolvencies at lowest level since 2005 BBC News (29/4/15)
Personal insolvencies drop to lowest level in a decade The Guardian, Press Association (29/4/15)
Corporate insolvencies at lowest level since 2007 The Telegraph, Elizabeth Anderson (30/4/15)
Interview: R3 President Phillip Sykes Accountancy Age, Richard Crump (1/5/15)
North-South gap widens in personal insolvencies Independent, Ben Chu (27/4/15)
Insolvency rates show ‘stark’ north-south divide Financial Times, James Pickford (27/4/15)
Questions
- What is meant by insolvency?
- There are many factors that might explain why the number of insolvencies has fallen. Explain the economic theory behind a lower inflation rate and why this might have contributed to fewer insolvencies.
- How might lower interest rates affect both the number of personal and corporate insolvencies?
- Why has there been a growth in the north-south divide in terms of the number of insolvencies?
- Do you think this data does suggest that lessons have been learned from the Credit Crunch?
The US economy has been performing relatively well, but as with the UK economy, growth in the first quarter of 2015 has slowed. In the US, it has slowed to 0.2%, which is below expectations and said to be due to ‘transitory factors’. In response, the Federal Reserve has kept interest rates at a record low, within the band 0.0% to 0.25%.
The USA appears relatively unconcerned about the slower growth it is experiencing and expects growth to recover in the next quarter. The Fed said:
“Growth in household spending declined; households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high. Business fixed investment softened, the recovery in the housing sector remained slow, and exports declined.”
Nothing has been said as to when interest rates may rise and with this unexpected slowing of the economy, further delays are likely. An investment Manager from Aberdeen Asset Management said:
“The removal of the Fed’s time dependent forward guidance could be significant. It means that any meeting from now on could be the one when they announce that magic first rate rise.”
Low rates will provide optimal conditions for stimulating growth. A key instrument of monetary policy, interest rates affect many of the components of aggregate demand. 
Lower interest rates reduce the cost of borrowing, reduce the return on savings and hence encourage consumption. They can also reduce mortgage repayments and have a role in reducing the exchange rate. All of these factors are crucial for any economic stimulus.
Analysts are not expecting rates to rise in the June meeting and so attention has now turned to September as the likely time when interest rates will increase and finally reward savers. Any earlier increase in rates could spell trouble for economic growth and similar arguments can be made in the UK and across the eurozone. The following articles consider the US economy.
Federal Reserve keeps interest rates at record low BBC News, Kim Gittleson (29/4/15)
Shock stalling of US economy hits chances of early Fed rate rise The Guardian, Larry Elliott (29/4/15)
US Fed leave interest rates unchanged after poor GDP figures Independent, Andrew Dewson (30/4/15)
Fed could give clues on first interest rate hike USA Today, Paul Davidson (28/4/15)
Fed’s downgrade of economic outlook signals longer rate hike wait Reuters, Michael Flaherty and Howard Schneider (29/4/15)
Five things that stopped the Fed raising rates The Telegraph, Peter Spence (29/4/15)
Questions
- By outlining the key components of aggregate demand, explain the mechanisms by which interest rates will affect each component.
- How can inflation rates be affected by interest rates?
- Why could it be helpful for the Fed not to provide any forward guidance?
- What are the key factors behind the slowdown of growth in the USA? Do you agree that they are transitory factors?
- Who would be helped and harmed by a rate rise?
- Consider the main macroeconomic objectives and in each case, with respect to the current situation in the USA, explain whether economic theory would suggest that interest rates should (a) fall , (b) remain as they are, or (c) rise.
A new group of economies, known as MINT, are seen as strong current and future emerging markets. We’ve had the BRICS (Brazil, Russia, India, China and South Africa) and now we have the MINTs (Mexico, Indonesia, Nigeria and Turkey).
In 2014, Nigeria became Africa’s fastest growing nation. A large part of Nigeria’s success has to do with growth in some of its key industries.
Nigerian’s reliance on the oil and gas industry created an attractive economy for further development and it now has high growth in a diverse range of sectors, including mobile phones, champagne, private jets and ‘Nollywood’. Despite the uncertainty and political unrest caused by Boko Haram, Nigeria is attracting a significant amount of Foreign Direct Investment (FDI) in a range of sectors, indicating its growing diversity and attractiveness to some of the world’s largest multinational companies.
Boko Haram has certainly had a dampening effect on Nigeria’s growth, as has the lower oil price, but this may create opportunities for further diversification. Furthermore there are concerns about how the wealth of the nation is concentrated, given that poverty is still prevalent across the country. However, Nigeria is certainly emerging as a success story of Africa and surely the question that will be asked is will other African nations follow suit?
The following article from BBC News considers the Nigerian economy.
Nigeria’s ‘champagne’ economy bucks Boko Haram effect BBC News, Vishala Sri-Pathma (27/3/15)
Questions
- Is a falling oil price necessarily bad for the Nigerian economy?
- Explain why Boko Haram is likely to have a dampening effect on economic growth in Nigeria.
- Do you think other African nations will be able to replicate the success of Nigeria? Which factors may prevent this?
- If the number of millionaires is increasing significantly, but poverty is persisting, does this tell us anything about what is happening to inequality in Nigeria?
- Is is possible to reduce inequality in Nigeria while maintaining economic growth? Might it even be posible for greater equality to be a driver of economic growth?
- The Nigerian currency is weakening. What has caused this and why may this be a cause for concern?
The CPI index fell by 0.1% in the 12 months to April 2015. This is partly the result of lower air and sea fares, as the upward ‘blip’ in these fares at Easter last year was not present in mid-April this year as Easter fell outside the period when the statistics are collected. What is more significant is that fuel, commodity and retail food prices have fallen over the past 12 months, and the exchange rate has risen, especially against the euro.
