A clear feature of 2015 has been the disinflationary pressure provided by the fall in the price of crude oil and other commodities. This has meant that in the UK the official Consumer Price Index has pretty much been at 0% so according to it there has been no inflation. Regular readers will be aware that I think that there are a litany of problems with that but I would like us for a bit to move forwards in a world where we are less well-informed. This of course is the alternative universe in which central bankers like to live so with further ado let us take a look at the thoughts of the Bank of England’s Underground blog on this. As it is nearly the weekend let us not wait for some jam tomorrow when we can have the Jam today.
I’m going underground, (going underground)
Well the brass bands play and feet start to pound
Going underground, (going underground)
Well let the boys all sing and the boys all shout for tomorrow
I think that this must be printed on the corridors of the Bank of England or is a compulsory screensaver. So here is the opening salvo in the deflation expectations war.
If the car you’re thinking of buying may be £500 cheaper in six months’ time, why not wait until then to buy it? This kind of thinking is one reason why falling prices trouble central bankers. The spectre of deflation is especially dangerous when households keep delaying their spending in expectation of further price falls.
Er because you may need a car now? Or in our increasingly fast paced world where nobody seems able to wait for anything how many would do that? Sorry for such heretical thoughts and let us carry on in our alternate universe.
The latest Bank of England survey asked questions about such matters but had an obvious problem for even a central banker. We do not have deflation. Oh Well! As Fleetwood Mac put it we can tell everyone how good inflation is.
Households who expect prices to rise more quickly are often thought to be more likely to raise spending now. If things will be more expensive tomorrow, why wouldn’t you buy them today and beat the price rise if you can afford to do so.
The last sentence is a statement when I think that it is in fact a question. So how does it work exactly?
More technically, one channel this works through is a lower real interest rate – the rate paid to borrow money minus the expected rate of inflation.
Ah so central bankers sometimes struggle with real interest-rates but the ordinary citizen or what in America is called Joe Sixpack has no trouble at all apparently! Perhaps it is something like Arsene Wenger and goalkeeper selection which also exists in an alternate universe which nobody else can fathom. I wonder if these sort of economic models have been affected by the fact that mostly people spend pretty immediately these days and until recently we have had inflation leading to the conclusion that inflation is good.
Now please do not misunderstand me I am sure that someone somewhere delays spending due to deflation and that someone spends in say Ukraine because things will be more expensive quickly. But overall how much of an impact is it? Also deflation can be caused by policy mistakes as we have seen in Greece so policy makers such as central bankers need to take care here. After all they have proved to be far from omnipotent – well outside their own press releases – in the credit crunch era and indeed before it.
A problem for central banker think
You might like to peruse the chart below which is something of an own goal.
We have a Houston we have a problem moment. Our intrepid central bankers seem to have overlooked somewhat that the inflation expectations surveys are giving a very different answer to the central banker inspired CPI! It is 0% but they are roughly in the 1% to 2% range. A bit like in a Pantomime when the audience shout out “We don’t believe you” and “behind you”. Perhaps they have been looking at house prices or their rent bills which in a central bankers world are redacted.
Also is it rude to point out that the surveys gives quite a similar answer to the much derided Retail Price Index? Whilst it has flaws in its composition I have long argued a case which was put well by Sherlock Holmes.
How often have I said to you that when you have eliminated the impossible, whatever remains,however improbable, must be the truth?’
The issue of real wages
These do appear in the analysis if you dig away..
There is clear evidence that income expectations are important for spending decisions, and these have been improving recently.
True although it gets meshed it with income actually rising and of course we have the issue of trying to differentiate between nominal and real incomes. Actually in the UK if we use official inflation we do not have to as it is 0%. Meanwhile in the real world anybody who goes to buy a house suddenly faces falling real incomes. Oh Well say our central bankers. Perhaps they model themselves on the arithmetic of Alice In Wonderland.
I’ll try if I know all the things I used to know. Let me see: four times five is twelve, and four times six is thirteen, and four times seven is – oh dear! I shall never get to twenty at that rate!
My contention is that lower inflation has boosted the economy via improving real wages.These had something of a nuclear winter back in 2010/11 as the Bank of England looked the other way as inflation surged and explain why our economy struggled back then but now they are benefiting from lower inflation as I explained back on January 29th.
However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.
If we look at the retail sales pattern for the UK in 2015 this theme has continued.
the volume of retail sales in August 2015 is estimated to have increased by 3.7% compared with August 2014……..Average store prices (including petrol stations) fell by 3.3% in August 2015 compared with August 2014.
Unlike central bankers I realise that other factors are also at play but so far things have turned out much more in line with my thoughts in this area than theirs. If we go back to January 29th then I predicted how they would behave.
If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.
Lower inflation has clear benefits as I have explained above. However the picture is not as simple as central bankers and their acolytes would have us believe. In the UK currently we have disinflation in the retail sales sector but inflation in house prices and rents as I discussed only yesterday. By obsessing on the deflation issue central bankers are in danger of creating Monsters of the Id as the film Return To The Forbidden Planet put it. Or singing along to the song below may create something of a self-fulfilling prophecy. As AC/DC put it.
I’m on the highway to hell
On the highway to hell
Highway to hell
I’m on the highway to hell
Of course other combinations between England and Australia are not likely to be so fraternal this weekend!
Thank you to those who were complimentary on my entry into the City AM top hundred economists list last week at number 23 . This week I rose to number n-n-n–nineteen.
Some Friday Music
Perhaps for the weekend or to while away the time before the US Labo(u)r Market numbers but Twitter has sprung up with some suggestions.
Lady FOHF: Alabama Song (Whisky Bar) by The Doors
Shireblogger: Bad To the Bone by George Thorogood and the Destroyers.
I had seen a mention of George for years and added this
I Wont Back Down by Tom Petty and the Heartbreakers