0% Inflation Is Bad News (Not That You Would Know It From The Media)

by George_East on March 24, 2015

225px-George_Osborne_0437Expect a whole bunch more George Osborne Is Jesus headlines tomorrow because the ONS announced today that inflation  in the year to February was 0%.  In the world of Media Macro (copyright Simon Wren-Lewis) this is to be celebrated because inflation means Zimbabwe or Weimer Germany, or even worse, whisper it with dread, the 1970s.

Yet the Bank of England target for inflation is not 0%.  It is not below 2%.  It is 2%.  If this target is missed by a significant level (either way) the Governor of the Bank of England, Mark Carney, has to write to the George Osborne to explain why the target has been missed.   Now the target was set when the Bank of England gained its independence way back in the first days of the Blair administration.  The reason it was set as a symmetrical target was not because of Labour’s inflationary ways but because deflation is not a good thing.  Not at all.  And let’s be clear if you have 0% inflation, you are within the margin of error of a deflation.

Deflation is bad because it makes debt more expensive. If debt is more expensive the incentive on businesses and householders is to pay the debt down lest it becomes more expensive still.  It was a collective desire to pay debt down that led to the liquidity crisis at the heart of the financial crisis of 2008/9 in the first place.   The risk is that as debt is paid down, aggregate demand falls and prices are cut further leading to a deflationary spiral.   The reference point is not the 1970s but the 1930s.

Now part of the explanation for inflation being non-existent is undoubtedly the fall in oil and other commodity prices that has been experienced over the last year or so (caused in part by shale gas coming on to the market in vast quantities in the states and the Gulf States not compensating by easing up on oil production).   So we may not yet be in deflationary territory.   However, the headline figures will drive expectations and that in itself is a dangerous thing.

The truth is that the Bank of England inflation target does need reviewing, but it needs revising upwards not downwards.  A target of 4% or even 5% would require far more aggressive monetary policy on the part of the Bank of England and more importantly, if achieved, would encourage spending not saving, as debt would become less burdensome over time.

Sadly, Labour does not even know how to frame an economic argument around these points.  It is too terrified of being painted as being relaxed about inflation.  Of playing into the media myth (rather than the reality) of the 1970s.   So not only will we get even more crowing about the Tories’ economic miracle over the coming days based on what is bad (not good) news but Labour won’t even put up a counter argument.

It would be embarrassing if it wasn’t so scary.

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