Why inflation is bad for so many people

Today I wish to address what is one of the major economic swizzles of our time. That is the drip drip feed by the establishment and a largely supine media that inflation is good for us, and in particular an inflation rate of 2% per annum is a type of nirvana. This ignores the fact that that particular number was chosen by the Reserve Bank of New Zealand because it “seemed right” back in the day. There was no analysis of the benefits and costs.

On the other side of the coin there has been a major campaign against low or no inflation claiming it is the road to deflation which is presented as a bogey(wo)man. There are several major problems with this. The first is that many periods of human economic advancement are exhibited this such as the Industrial Revolution in the UK. Or more recently the enormous advances in technology, computing and the link in more modern times. On the other side of the coin we see inflation involved in economies suffering deflation. For example Greece saw consumer inflation rising at an annual rate of over 5% in the early stages of its economic depression. That was partly due to the rise in consumer taxes or VAT but the ordinary Greek will simply feel it as paying more. Right now we see extraordinary economic dislocation in Argentina where a monthly inflation rate of 4% in August comes with this from Reuters.

The country’s economy shrank 2.5% last year and 5.8% in the first quarter of 2019. The government expects a 2.6% contraction this year.

Argentina’s unemployment rate also rose to 10.6% in the second quarter from 9.6% in the same period last year, the official INDEC statistics agency said on Thursday.

The Euro Area

The situation here is highlighted by this release from the German statistics office this morning.

Harmonised index of consumer prices, September 2019
+0.9% on the same month a year earlier (provisional result confirmed)
-0.1% on the previous month (provisional result confirmed)

This is around half of the European Central Bank or ECB inflation target so let us switch to its view on the subject.

Today’s decisions were taken in response to the continued shortfall of inflation with respect to our aim. In fact, incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures. This is reflected in the new staff projections, which show a further downgrade of the inflation outlook.

That is from the introductory statement to the September press conference. As you can see it is a type of central banking standard. But later Mario Draghi went further and to the more intelligent listener gave the game away.

The reference to levels sufficiently close to but below 2% signals that we want to see projected inflation to significantly increase from the current realised and projected inflation figures which are well below the levels that we consider to be in line with our aim.

My contention is that this objective makes the ordinary worker and consumer worse off.

Real Wages

The behaviour of real wages has changed a lot in the credit crunch era. If we look at my home country the UK we see that nominal wage growth has only recently pushed above an annual rate of 4%. But if we look at the Ivory Tower style projections of the OBR it should have pushed above 5% years ago based on Phillips Curve style analysis like this from their report on the 2010 Budget.

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014…………Thereafter, the more rapid increase in employment is sufficient to lower unemployment, so that the ILO unemployment rate falls to
6 per cent in 2015.

As you can see wages growth was supposed to be far higher than now when unemployment was far higher. If they knew the number below was associated with a UK unemployment rate of below 4% their computers would have had a moment like HAL-9000 in the film 2001 A Space Odyssey.

The equivalent figures for total pay in real terms are £502 per week in July 2019 and £525 in February 2008, a 4.3% difference.

Real pay still has some distance to go to reach the previous peak even using a measure of inflation ( CPIH) that is systematically too low via its use of Imputed Rents to measure owner-occupied housing inflation.

It is the change here which means that old fashioned theories about inflation rates are now broken but the Ivory Tower establishment has turned a Nelsonian style blind eye to it. Let me illustrate by returning to the ECB press conference.

While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Over the medium term underlying inflation is expected to increase, supported by our monetary policy measures, the ongoing economic expansion and robust wage growth.

This is the old assumption that higher inflation means higher wage growth and comes with an implicit assumption that there will be real wage growth. But we have learnt in the credit crunch era that not only are things more complex than that at times things move in the opposite direction. There is no former rejection of Phillips Curve style thinking than the credit crunch history of my country the UK. Indeed this from the Czech National Bank last year is pretty damning of the whole concept.

Wage dynamics in the euro area remain subdued even ten years after the financial crisis. Nominal wage growth1 has seldom exceeded 2% since 2013 (see Chart 1). Wages have not accelerated significantly even since 2014, when the euro area began to enjoy rising economic growth and falling unemployment. Following tentative signs of increasing wage growth in the first half of 2017, wages slowed in the second half of the year.


It is the breakdown of the relationship between wages and inflation that mean that the 2% inflation target is now bad for us. The central bankers pursue it because one part of the theory works in that gentle consumer inflation helps with the burden of debt. The catch is that as we switch to the ordinary worker and consumer they are not seeing the wage increases that would come with that in the Ivory Tower theory. In the UK it used to be assumed that real wage growth would be towards 2% per annum whereas in net terms the credit crunch era has shown a contraction.

If we look at the United States then last week’s unemployment report gave us another signal as we saw these two factors combine.

The unemployment rate declined to 3.5 percent in September, and total nonfarm
payroll employment rose by 136,000, the U.S. Bureau of Labor Statistics reported
today………In September, average hourly earnings for all employees on private nonfarm payrolls,
at $28.09, were little changed (-1 cent), after rising by 11 cents in August. Over the
past 12 months, average hourly earnings have increased by 2.9 percent.

It is only one example but an extraordinary unemployment performance saw wage growth fall. There have been hundreds of these butt any individual example the other way is presented as a triumph for the Phillips Curve. Yet the US performance has been better than elsewhere.

Oh did I say the US has done better, Here is the Pew Research Center from last year.

After adjusting for inflation, however, today’s average hourly wage has just about the same purchasing power it did in 1978, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.

All of this is added to by the way that rises in the cost of housing are kept out of the consumer inflation numbers so they can be presented as beneficial wealth effects instead.

20 thoughts on “Why inflation is bad for so many people

  1. Hello Shaun,

    re:” The catch is that as we switch to the ordinary worker and consumer they are not seeing the wage increases”

    It is truly despicable that HMG can increase benefits by CPI but raises taxes by RPI ( an their own pensions schemes by RPI ) .

    That for all the wrong reasons that housing , food, and fuel are excluded ( and tax rises are too I believe , ie rates) .

    Thus the CPI is artificial and can be considered “fake” news by the public.

    Before the convenience of the NZ national bank figure the CB used to pursue a 0% inflation target……

    Perhaps its not just debt reduction but because they do not have the tools or the courage to get to 0% , or just not running to rules they tell us they are following ;-(

    nobody in MSM seems to notice ….


    • forbin,

      This topic been discussed previously but I agree with you that most of the figures are inaccurate.

      However I can understand why they want inflation of 2% they don’t want hyper inflation that is damaging neither do they want deflation.

      They could seek to zero inflation but in theory that would mean on average peoples wages stall.

      The problem with zero inflation is people to improve their standards and in theory zero inflation wont!

      I appreciate every ones circumstances different regardless of any inflation effect if one could borrow less than the inflation rate then debt would decrease and that person’s financial wealth improve.

      That may sound daft but it isn’t is I have a tracker mortgage with Woolwich and at 0.38% above base and my debt reduced. But those deals are no longer available.

      Taking all things into account a small amount of inflation may be best to achieve to make the public feel their circumstances are on an improving trend.

      I have limited knowledge about economics and rely on my simple approach, that said many wont agree with me but some may do.

      On other topics today, BREXIT has more optimism so the £ rose and the stock market 250 soared. The footsie 100 flat but a stronger pound is not as good for footsie 100 as they are $ earners.

      BREXIT may have given more optimism but any deal has to get through Parliament and that is one mighty hurdle so I expect more volatility to come.

      Borris is playing hard ball he is capable of taking it to the wire on the belief that I think that Europe do not want the damage a no deal would cause to them as Europe is in a mess in a global slowdown without BREXIT worries.

  2. Great article as alwats Shaun.

    The public do not understand inflation (apart from houseprices) and the TPTB take full advantage of this. Inflation does not benefit most people and yet the BOE active work against the public making the basic cost of living more expensive.

    I feel that this is one of the main drivers of poverty in this country. The boe looking through inflation of basic necessities which disproportionately mpacts low income families.

    • wasn’t the tenant from the Labour party ( of all people ) that inflation was a stealth tax on the poor ?

      ( and I’d posit the middle classes as well , seem to be a shrinking group these days ….. oh bother , if the poor can’t pay and the rich won’t , and there’s no middle class ……. sorry was that the plan all along ? )



  3. I’ll leave it to the words of Thomas Jefferson who gave the following warning:

    “If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered…. I believe that banking institutions are more dangerous to our liberties than standing armies…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

  4. One attraction of a 2% target is it provides lots of room to fall short without going negative, whereas with a 0% target there is no room at all. This matters because minus values look/read very badly to those who get their news in abbreviated form, which on nation-level finance is nearly everyone nowadays.

    • that is a good point , nice and round too , unlike say 1.5%

      3% a little too high but has been mooted at , 1% I guess a little close to 0%.


    • Hi, Arrbee. Shaun may want to respond to you, but it is a subject dear to my heart, so I wanted to reply immediately. In my 2017 paper “Why the Bank of Canada’s Target Rate of Inflation Should Be Lowered Rather Than Raised”, I took up the issue of a 0% target rate: “One thing that does seem certain is that the target rate will never be as low as zero percent, since the measurement bias is positive and whatever improvements are made it will remain so.” At the time of the 2016 renewal of the inflation-control agreement, the Bank of Canada claimed that the upward bias in the measure of Canadian inflation had been reduced from 0.5% at the time of the 2011 renewal agreement to 0.3%. I am personally a little skeptical it has gone that low, but for sure it was reduced. I have never seen an estimate for the UK CPI but Alistair Cunningham made a guesstimate of the upward bias of the UK RPI in 1996 that put it at 0.35% to 0.8%. His paper also showed a Bank of Canada estimate of Canadian CPI bias from Allan Crawford at up to 0.6%, this being a top of range rather than a point estimate. It is probably better in this case I would think to show some respect for differences of opinion. You want to set the target rate no lower than the zero rate of inflation plus the upward bias in measured inflation, and it would be a mistake to set it at 0.3%, if you are going to scare the wits out of people who think the upward bias is 0.6%, and this amounts to a deflationary target rate. I really don’t see this, at least in countries like Canada and the UK, as any argument for a 2% target rate. A 1% target rate, which was what Governor Crow wanted to see for the 1993 renewal of the inflation control agreement for Canada, is more like a natural place for a central bank to declare that price stability has been achieved. Nobody with any serious credentials would maintain that if the measured inflation rate was 1% the true rate of inflation was negative. Also, if one maintained a 2 percentage point range between the lower bound and the upper bound, a 1% target rate implies a 0% lower bound. People might get jittery if one went lower, so that a fair amount of the time the inflation rate would be negative. (You are going to get negative inflation rates sometimes even with a 1% target.) I would never support a target rate as low as 0% because of upward measurement bias. I might support a target rate lower than 1%, despite what I just wrote. Let’s get the target rate down to 1% in the UK for a few years and then we can talk.

    • The last forty years of consumer electronics – hardly an insignificant area of the economy – has shown that even quite strong deflation is not the all-consuming monster that bankers and politicians like to say it is, at least in the area of demand. There are other issues connected with debt and negative inflation, of course, but there’s no reason why 0% as a target should be avoided, assuming that reality will sometimes overshoot and sometimes undershoot.

      Positive inflation is the politician’s equivalent of burying their mistakes.

  5. Hi Shaun, yes it’s all NZ’s fault.
    From the RBNZ website-
    “Since 2000, New Zealand CPI (Consumers Price Index) inflation has averaged around 2.15 percent. This compares with averages of 2.4 percent in the 1990s, and averages of over 11 percent for the previous two decades. Since September 2002, the inflation target has been to keep inflation within a range of 1–3 percent on average over the medium term.”

    Not sure what “averaged around” means, but there we are. It was double digit inflation that spurred NZ into inflation targeting. When Don Brash talks about these days he says 1-3% was thought to be achievable; no more to it than that.

    • Hi Eric

      Shame about your game and indeed ours in the rugby world cup being cancelled. That sort of thing is hardly new as I recall Typhoon number 27 being a strong one when I was out in Japan. It did a lot of damage in Osaka and sadly even killed some people.

      As to the inflation targeting I agree that “around” looks rather odd when you have used 2 decimal places. Also these days it is often not clear what central banks mean by medium term. It used to be the case that inflation targets were aimed at 2 years ahead which is fair enough as that is the time it takes for policy changes to fully work. But now medium-term seems to mean whatever they want it too.

  6. Great blog as usual, Shaun.
    You write that a target inflation rate of 2% “was chosen by the Reserve Bank of New Zealand because it ‘seemed right’ back in the day.” Not so. As I have told you before, the RBNZ has never operated with a target rate of inflation, only a target range, only now it sort of does, as the RBNZ has, since its 2012 Policy Target Agreement with the New Zealand Government, had a 1% to 3% target range “”with a focus on keeping future average inflation near the 2 percent target midpoint”. So don’t blame them for the 2% target rate of inflation.
    As I wrote you before, the original target rate of inflation came out of the initial inflation-control agreement between Progressive Conservative Finance Minister Michael Wilson and Bank of Canada Governor John Crow in February 1991, which specified a target rate of 3% for the end of 1992, 2½% by the middle of 1994 and 2% by the end of 1995. Quoting from that original agreement: “Thereafter the objective would be further reductions in inflation until price stability is achieved. A good deal of work has already been done in Canada on what stability in the broad level of prices means operationally. This work suggests a rate of increase in consumer prices that is clearly below 2 per cent.” So the original 2% inflation target rate in the world, adopted for the Bank of Canada, was intended to be nothing more than a stepping stone towards an unspecified lower rate of inflation that would be consistent with price stability.
    If the blame for the 2% target rate of inflation should be assigned to any one person, it should go to incoming Liberal Finance Minister Paul Martin, who rushed the renewal of the inflation control agreement, which shouldn’t have taken place until the end of 1995. It was pushed forward to December 1993, coinciding with the end of Governor Crow’s term. Rather than announcing a reduction in the target rate of inflation, it extended the 2% rate through 1998, and then extended it again with the 1998 renewal. Martin would make almost anyone’s short list as one of the great Canadian Finance Ministers of all time, but here he really did not serve the interests of the Canadian people very well, or, as it would now seem, the people of the world. John Crow, who was a Londoner by birth like yourself, put some flesh on the bones of what stability in the broad level of prices meant operationally in his mind in practice. He favoured a 1% target rate after 1995 in the renewal agreement. Judging from the original agreement, this would have been arrived at in phases, going first to a 1.5% target rate, then to a 1% rate, but I am just guessing. Two future Governors of the Bank of Canada, Gordon Thiessen and David Dodge, negotiating on Martin’s behalf, suggested “keeping the top of the band at 3 per cent but lowering the bottom to 0.5 per cent” which implied a 1.75% target rate. This proposal was, perhaps unwisely, rejected by Crow, as it would at least have kept the target rate moving in the right direction, and we might not now be living in a 2% world. In his memoirs, Crow writes as an alternative a target end range of 0.5 to 2.5 per cent, which yielded a mid-point ‘clearly below 2 per cent,’ as a specified working definition of price stability for the indefinite future, but this was rejected out of hand.Crow’s final offer was a 1.5% target rate, which would be considered as the target for the indefinite future, but Martin rejected this out of hand. Crow refused to go along with this, and the renewal agreement and Crow’s replacement as Governor of the Bank of Canada by Gordon Thiessen were announced at the same time.
    I have gone into this in gory detail here, because the history of the 2% rate seems to be poorly understood everywhere, including Canada. It is obvious when one does get into the details just how avoidable the adoption of the 2% target rate as the indeterminate of the Bank of Canada really was. If Crow had been more accommodating, it might have been 1.75%. If Martin had been more accommodating it might have been 1.5%, or something lower.
    Sadly, while there is still a constituency among monetary economists like David Laidler for a lower target rate in this country, there no longer seems to be any political constituency for one. Maxime Bernier, who came ever so close to winning the leadership of the federal Conservative Party, promoted price stability and a lower target rate of inflation during his election campaign. When he left the Conservative Party and created the People’s Party of Canada, I thought we would have at least one party that would champion a lower target rate, but it is not part of the PPC platform, nor did he mention it in either of the leaders’ debates, which ended with the French language debate yesterday. I know you don’t like discussing politics in your blog, but it is disappointing that not only has no party put a lower target rate of inflation in their platform, none, to my knowledge, has even made a commitment to keeping the target rate from rising. It looks like in 2021 we could well see the rate going back up again to the 3% target that was initially specified in February 1991 for the end of 1992. To the extent that people in the parties’ hierarchies think about this issue at all, and I suspect some of them do, they are probably not adverse to a higher target rate. Whether you want to carry on with deficits ad infinitum, like the Liberals, or balance the budget in five years (outside of their electoral mandate!) like the Conservatives, or in two years, like Maxime’s PPC, there are advantages to having more of your debt simply inflated away.

  7. It’s my understanding that when a country borrows money it just borrows more to pay off the original debt

    So what happens if Inflation remains low but the interest rate demanded by those who buy government debt increases as the bulk of your cheap borrowings is up for renewal?

    • Hi mwhite

      Then you can be in trouble because if you keep having to pay a higher yield on your debt then your debt interest bill rises. More specifically the higher yield is multiplied by your fiscal deficit and the debt which needed refunding.

      This can create issues and I have worked through at least a couple of episodes in the past where this has put pressure on the UK government at the time. More recently the best example is perhaps from the Euro area crisis circa 2012 where Greece, Ireland and Portugal looked rather insolvent if bond yields stayed where they were. Hence the bailouts….

  8. Shaun,

    Off topic I read some of your response to Danny Blancflower yesterday, and do agree DB is ever so negative on the UK economy regardless of the figures.

    He doesn’t like the present government policies he, is damning of Treason Mays austerity measures as being a terrible policy, I think he is labour minded but hates Corbyn as well. I don’t know who he would vote for if he was in the UK now.

    He seems to be damning of Trump as well in fact I think he feels like he is the worlds best financial guru in economics!

    I do follow his twitter comments however I don’t dismiss them completely, he does come up sometimes with reasonable arguments and his twitter site does put out useful statistics regardless of his opinion on the same.

    he doesn’t like being criticised and can be quite rude to people often.

    In the financial crisis I watched many of his TV debates and took much notice of the female FT editor which I have forgotten her name who moved to the US. I think she predicted a financial crash. She talked a lot of sense at the time suggesting that defaults would have to happen some would have to suffer pain. I tend to agree with those thoughts a continued debt spiral and printing of money cannot go on forever.

    • Hi Peter

      Danny is a political type economist who takes the Labour line and spent ages calling Chancellor Osborne “slasher” and worse. That is his choice as I do my best to avoid politics but it gets him into situations where surely he must know he is wrong.

      Also he seems to have no nuance. Those who follow my work will know that I think that there are worries about such as manufacturing. But the GDP numbers took us away from recession and had 2 upwards revisions so that’s what I reflected on. He though cannot accept that but we both know that he would have been all over them if they had pointed towards recession!

      I think you mean Gillian Tett. I suggested her as head of the IMF back in the day and she would undoubtedly been better than Christine Lagarde,

      • Shaun,

        The older I get the worse I am for names and yes it was Gillian Tett I thought she had a very good understanding about the crisis and what is really required. Very impressed indeed with the lass.

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