http://www.telegraph.co.uk/finance/c...-bogeyman.html
So whatever happened to the deflation bogeyman?
Three months ago, the Bank of England published a Quarterly Inflation Report that, amidst the usual macroeconomic forecasts, contained a detailed analysis of the threat posed by deflation.
The dreaded "d-word" received top-billing – evoking the traumas of the Great Depression, rising real debt burdens, warped economic incentives and Japan's "lost decade".
In its latest Inflation Report, published last week, the Bank made less of the deflationary dangers we face. A lot less. The word "deflation", in fact, didn't make a single appearance.
So let me get this straight. One minute the UK faces an issue so dangerous, so imminent, that we take extremely drastic measures to tackle it: "quantitative easing" and our debt-fuelled fiscal-boost were both introduced "to fend off the threat of deflation".
Over the last few months, we've printed money on an unprecedented scale and run up enormous extra liabilities. When sensible people have protested, pointing out the clear dangers, we've been told such "bold" measures were necessary for the UK to avoid getting sucked into a deflationary spiral.
But now, just three months later, this looming threat has apparently passed. It warrants not a mention in the Bank's Inflation Report. Has deflation really gone away? Or did we never actually face such dangers? Was the spectre of deflation conjured up, instead, for other reasons – as an excuse for this ghastly Government to yank monetary policy back off the Bank and nail interest rates to the floor, while junking fiscal caution and borrowing in a fashion more akin to a banana republic?
The Bank of England has stopped warning of deflation because it is no longer credible to do so. In truth, it never was. CPI inflation remains at 2.9pc – way above the Bank's target, as it has been for 31 of the last 33 months. As sterling has fallen, import prices have surged. In an open economy like the UK, that's highly inflationary.
A few City economists are still banging the deflationary drum, so desperate are their battered institutions to keep wringing "bail-out" cash from the Government, or use QE to recapitalise themselves by the back door.
But most of the financial markets, and the population as a whole, know deflation is nonsense. Price pressures remain high. More than that, concern is growing that our policy response to "sub-prime" –cranking-up the Bank's printing presses and drowning ourselves in more debt, and all against a backdrop of negative real interest rates – is itself storing up high inflation.
At a recent Euromoney conference, a large, financially-savvy audience was asked to choose which phrase – "deflation", "inflation soon" or "big inflationary problems in the future" – best describes their expectations. The result was decisive, with more than four-fifths concerned there could be serious inflation to come.
That's why the Bank has done a handbrake turn. Three months ago, the Inflation Report forecast that economic slowdown meant CPI inflation would fall to 0.6pc by the end of 2010 – still not in negative deflationary territory, but close. Last week, the Bank raised that forecast sharply, predicting a CPI close to 1.5pc at the end of next year.
At the same time, the Bank now sees the downturn getting deeper. The economy will shrink 3.8pc this year, it says, before growing 1.1pc in 2010. Just three months ago, a 2.3pc growth rate was pencilled in for next year.
So the Bank has raised it inflation forecast, but slashed its future growth rate. Less growth would normally mean less inflation, not more. But in this case, our efforts to avoid the inevitable fallout from "sub-prime" – the money-printing and all the extra borrowing – have stoked up future price pressures. In the coming months, these policy excesses will weigh on sterling, raising import prices further. Next year's VAT cut reversal will add to inflation too.
Oil prices are now up sharply – some 40pc above their mid-February low. And crude could go much higher still, again feeding inflation.
But the Bank pointed to another source of inflation that, while significant, has barely been discussed. By cutting working capital to companies, the credit crunch has restricted their ability to supply goods and services. Many firms are now folding, leaving competitors with more pricing power.
The current lack of credit isn't only destroying demand, but also the economy's ability to supply. As last's week's Inflation Report was launched, Charlie Bean, the Bank's Deputy governor, warned the crunch was curtailing investment and eroding skills. That lowers the output level the economy can sustain without triggering inflation.
Its lately been argued that because the slowdown results in "spare capacity", the Government can print money and borrow like crazy without provoking inflation. But as Bean said: "The rise in spare capacity isn't as large as you would think simply from the projections of growth".
Inflation is coming – don't doubt it. The penny has now dropped.
Slipping up on PFI
Readers may recall my previous tirades against the private finance initiative (PFI). Expensive and inefficient, PFI means taxpayers often shell out ridiculous amounts for sub-standard schools, hospitals and other public infrastructure.
Having been paid over the odds for the building, the private sector then adds insult to injury by providing sloppy, overpriced services, under 25-year contracts allowing them to do as little as possible while extracting maximum public cash.
Why have Labour, and the Tories before them, signed PFI contracts worth hundreds of billions when the private sector could have been engaged on more flexible terms, providing far better taxpayer value?
Because a succession of clever-clever civil servants, supposedly negotiating on our behalf, have cut deals stacked in the private sector’s favour. It is a complete coincidence some then went to work for the PFI industry.
The main attraction, though, is that PFI allows ministers to park billions of pounds of debt off-balance-sheet – a public-sector Enron.
Several years ago, HM Treasury agreed to heed IFRS accounting rules by bringing all PFI liabilities onto its books. Last week, a low-key announcement broke that promise. PFI debts will remain off-balance-sheet but projects may have two sets of accounts – one meeting IFRS standards, the other for internal consumption. Another small step into banana republic territory.
So whatever happened to the deflation bogeyman?
Three months ago, the Bank of England published a Quarterly Inflation Report that, amidst the usual macroeconomic forecasts, contained a detailed analysis of the threat posed by deflation.
The dreaded "d-word" received top-billing – evoking the traumas of the Great Depression, rising real debt burdens, warped economic incentives and Japan's "lost decade".
In its latest Inflation Report, published last week, the Bank made less of the deflationary dangers we face. A lot less. The word "deflation", in fact, didn't make a single appearance.
So let me get this straight. One minute the UK faces an issue so dangerous, so imminent, that we take extremely drastic measures to tackle it: "quantitative easing" and our debt-fuelled fiscal-boost were both introduced "to fend off the threat of deflation".
Over the last few months, we've printed money on an unprecedented scale and run up enormous extra liabilities. When sensible people have protested, pointing out the clear dangers, we've been told such "bold" measures were necessary for the UK to avoid getting sucked into a deflationary spiral.
But now, just three months later, this looming threat has apparently passed. It warrants not a mention in the Bank's Inflation Report. Has deflation really gone away? Or did we never actually face such dangers? Was the spectre of deflation conjured up, instead, for other reasons – as an excuse for this ghastly Government to yank monetary policy back off the Bank and nail interest rates to the floor, while junking fiscal caution and borrowing in a fashion more akin to a banana republic?
The Bank of England has stopped warning of deflation because it is no longer credible to do so. In truth, it never was. CPI inflation remains at 2.9pc – way above the Bank's target, as it has been for 31 of the last 33 months. As sterling has fallen, import prices have surged. In an open economy like the UK, that's highly inflationary.
A few City economists are still banging the deflationary drum, so desperate are their battered institutions to keep wringing "bail-out" cash from the Government, or use QE to recapitalise themselves by the back door.
But most of the financial markets, and the population as a whole, know deflation is nonsense. Price pressures remain high. More than that, concern is growing that our policy response to "sub-prime" –cranking-up the Bank's printing presses and drowning ourselves in more debt, and all against a backdrop of negative real interest rates – is itself storing up high inflation.
At a recent Euromoney conference, a large, financially-savvy audience was asked to choose which phrase – "deflation", "inflation soon" or "big inflationary problems in the future" – best describes their expectations. The result was decisive, with more than four-fifths concerned there could be serious inflation to come.
That's why the Bank has done a handbrake turn. Three months ago, the Inflation Report forecast that economic slowdown meant CPI inflation would fall to 0.6pc by the end of 2010 – still not in negative deflationary territory, but close. Last week, the Bank raised that forecast sharply, predicting a CPI close to 1.5pc at the end of next year.
At the same time, the Bank now sees the downturn getting deeper. The economy will shrink 3.8pc this year, it says, before growing 1.1pc in 2010. Just three months ago, a 2.3pc growth rate was pencilled in for next year.
So the Bank has raised it inflation forecast, but slashed its future growth rate. Less growth would normally mean less inflation, not more. But in this case, our efforts to avoid the inevitable fallout from "sub-prime" – the money-printing and all the extra borrowing – have stoked up future price pressures. In the coming months, these policy excesses will weigh on sterling, raising import prices further. Next year's VAT cut reversal will add to inflation too.
Oil prices are now up sharply – some 40pc above their mid-February low. And crude could go much higher still, again feeding inflation.
But the Bank pointed to another source of inflation that, while significant, has barely been discussed. By cutting working capital to companies, the credit crunch has restricted their ability to supply goods and services. Many firms are now folding, leaving competitors with more pricing power.
The current lack of credit isn't only destroying demand, but also the economy's ability to supply. As last's week's Inflation Report was launched, Charlie Bean, the Bank's Deputy governor, warned the crunch was curtailing investment and eroding skills. That lowers the output level the economy can sustain without triggering inflation.
Its lately been argued that because the slowdown results in "spare capacity", the Government can print money and borrow like crazy without provoking inflation. But as Bean said: "The rise in spare capacity isn't as large as you would think simply from the projections of growth".
Inflation is coming – don't doubt it. The penny has now dropped.
Slipping up on PFI
Readers may recall my previous tirades against the private finance initiative (PFI). Expensive and inefficient, PFI means taxpayers often shell out ridiculous amounts for sub-standard schools, hospitals and other public infrastructure.
Having been paid over the odds for the building, the private sector then adds insult to injury by providing sloppy, overpriced services, under 25-year contracts allowing them to do as little as possible while extracting maximum public cash.
Why have Labour, and the Tories before them, signed PFI contracts worth hundreds of billions when the private sector could have been engaged on more flexible terms, providing far better taxpayer value?
Because a succession of clever-clever civil servants, supposedly negotiating on our behalf, have cut deals stacked in the private sector’s favour. It is a complete coincidence some then went to work for the PFI industry.
The main attraction, though, is that PFI allows ministers to park billions of pounds of debt off-balance-sheet – a public-sector Enron.
Several years ago, HM Treasury agreed to heed IFRS accounting rules by bringing all PFI liabilities onto its books. Last week, a low-key announcement broke that promise. PFI debts will remain off-balance-sheet but projects may have two sets of accounts – one meeting IFRS standards, the other for internal consumption. Another small step into banana republic territory.
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