A little inflation could go a long way

November 25, 1994

Though shifted from its historic springtime niche in what may have been Norman Lamont's one lasting achievement as Chancellor of the Exchequer, Budget Day remains one of the great rituals of British political life.

Kenneth Clarke may have to offer two set pieces for the price of one next Tuesday, when he unveils his second combined Budget and Autumn Statement to the House of Commons, but we can count on certain immutable elements of ritual. Mr Gladstone's bag will be brandished, Chancellor and spouse will be photographed on a mid-morning walk in the park and he will pause at some suitable point in mid-speech to refresh himself.

And most chancellors like to have some mild surprise up their sleeve to cheer the backbenches, wrongfoot the Opposition and give journalists something to write about. Mr Clarke -- whose sense of theatre was demonstrated by last year's teasing of the House over the possibility of imposing value- added tax on books and newspapers -- is no exception. But it is a fair bet that even his renowned chutzpah will fall short of the announcement that would really make the House gasp -- dropping containment of inflation as the Government's prime economic priority.

Fighting inflation has been the consistent theme of government rhetoric over the past 15 years -- the continual emphasis aimed as much as anything at distancing the Thatcher and Major administrations from their predecessors, from memories of 26 per cent inflation in the middle of the decade and the "Winter of Discontent" towards its end.

And, with the current rate around 2 per cent, they can claim a genuine triumph. Peter Jay, no government lackey, said in the recently published The Major Effect: "John Major stopped inflation. It may sound negative and lack inspirational or heroic proportions; but it is none the less a towering achievement, requiring quite extraordinary singleness of purpose, political courage and almost divine patience."

Such achievements matter. Along with the standard rate of income tax, the level of the pound and the level of unemployment, the retail price index is one of the headline indicators that helps define the give and take of political life.

Patrick Minford, professor of economics at Liverpool University and one of the Chancellor's "Seven Wise Men" advisory panel, sees no short-term likelihood of inflation rising again: "The prospects are very good. The forecasts are set at around 2 per cent as far as the eye can see and it is hard to see what is going to change that. There are no labour-market pressures and the Bank of England, which has been consistently over-pessimistic, has revised its forecasts down."

Government determination to keep things that way was underlined by the recent increase in interest rates, based on the assumption that inflationary pressures might mount in 18 months' to two years' time. Huw Dixon, professor of economics at York, welcomes evidence that the Chancellor -- generally regarded as a short-term tactician -- is prepared to think ahead: "There is a great deal of inertia and inflationary effects can take a year or twoto build up. And, as Milton Friedman said, 'interest rates have long and unpredictable effects'."

So success has been achieved in the terms the Government set for itself -- no bad thing when inability to keep promises is an accusation routinely levelled at politicians. But was the effort worth it, and having attained its objective should the Government press on with more of the same or alter its priorities?

As a Nottingham MP, Mr Clarke would doubtless be glad to hear that David Greenaway, professor of economics at Nottingham University, thinks he is on the right track. And Greenaway notes that, as well as conventional political pressures, the government is also under pressure to justify the greater autonomy now given to the Bank of England: "The preoccupation with inflation is as much as anything to do with establishing credibility for the arrangements under which the Bank of England rather than the Bundesbank operates. They are playing for the future as much as the present -- the aim is to prove to the markets that they can be trusted."

And among his panel of advisers, Mr Clarke finds broad support from David Currie, professor of economics and director of the Centre for Economic Forecasting at London Business School: "The situation is different to Britain in the 1970s, but there are still good reasons for keeping things tight. It is easy to say that inflation is well under control, but all it needs is some unforeseen shock and the rate can rise by 3 or 4 per cent, you are back to 6 or 7 per cent and under pressure again.

"The important thing is that the inflation rate should be reasonably stable, and the evidence we have is that stability is easier to achieve at low than at high rates."

Currie rejects the view of economists such as Karel Williams, reader in economics at Manchester University, who argue that an emphasis on inflation reflects British government's inherent preference for finance over industry. But what is not in question is that it does involve choosing winners and losers. Dixon may admire Mr Clarke's relative long-termism, but he still believes that the policy is being overdone: "Completely ignoring unemployment is extremely unwise, and can probably be blamed on economic theory and the assumption that there is a natural rate which is unaffected by macro-economic policy."

Concern is underpinned by the knock-on effects of unemployment -- demoralisation, ill-health and the serious difficulties in readjusting to work experienced by those who have spent a long time out of work. The view that current counter-inflation policies are holding back recovery finds an ostensibly surprising supporter in Minford.

Minford, to his evident delight, finds himself in alliance with Cambridge's Wynne Godley -- habitually regarded as his polar opposite among the panel.

He says: "What we are seeing is a huge overcorrection to the mistakes of the late 1980s. There are no labour-market pressures because virtually all the new jobs being created are part time. Productivity is rising faster than real wages -- so you have wage deflation. The (counter-inflation) policy is based on constantly mistaken and over-pessimistic forecasts and is holding back the recovery."

The attack on inflation has been based on a number of assumptions. One was that low rates would lead to economic growth. Karel Williams says: "This belief is theological. What the Government is actually doing is claiming credit for a typical British cyclical upturn, which can be made to look plausible because our cycles are slightly out of step with the rest of Europe. But they have abandoned any belief that they can control the real economy. What low inflation actually reflects is lack of activity and passivity in the labour market."

Jonathan Michie of Robinson College, Cambridge, detects other fallacies: "It is assumed that the economy is more stable, and there is no basis for this -- other variables are equally likely to need adjusting. And there is a common misconception that if you can get inflation to very low levels or even zero, it is likely to stay there. In fact, it is as likely to go up or down. Minus inflation is possible -- and highly damaging as people and companies see their debts increasing in real terms, particularly in a time of high interest rates."

And Paul Ormerod, former director of economics at the Henley Centre for Forecasting and author of The Death of Economics, punctures a further theory: "It is always argued that stable low inflation will lead to higher investment and growth. The British experience during the 1980s provides little support for that assumed relationship."

What nobody questions is that inflation is currently under control or that some sort of recovery is under way. What must gall the Government is that they are getting so little credit for it. Ormerod has a suggestion for that as well: "With low inflation and very high interest rates people don't feel well off -- they are too concerned about their debts. A little bit of inflation would make a lot of people feel better off."

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