Setting rates is no longer kids stuff

According to Roger Bootle writing in today’s Telegraph. The MPC does face an acute dilemma with evidence of surging cost push inflation and the real possibility (probability?) that CPI inflation will overshoot the 3% ceiling at some point in 2008. But Bootle argues that if the MPC is too cautious over interest rates, fearing a return to a wage-price spiral, then we might well suffer the slump in real output and jobs that characterised attempts to put the lid on rampant inflation in the 1970s and late 1980s.

“Until recently everyone thought that the MPC had done a wonderful job. But raising rates when the economy is booming and inflationary pressures are obviously building, or cutting them when the economy is weakening and inflationary pressures are collapsing, is all kids stuff. The difficult thing is what to do when the economy appears to be sliding towards recession and yet inflationary pressures are building. Stir in an international banking crisis and the picture is even more complicated. This is the position we are in now. Now the MPC faces a real test.”

I can certainly see the official measure of inflation shooting up in the summer months. There must be a limit to the ability of manufacturers and retailers to hold prices down and absorb some of the huge cost increases we have been seeing in recent months. But will there be a wage explosion? I sense this is unlikely given our flexible labour market and fears of rising unemployment as the housing market and economy weakens.