The Wrong Kind of Inflation?

Invited as the obligatory economist to my institution’s Salaries Committee, I spent lunchtime today discussing what sort of pay rise we deserve (huge, of course) and the sort of pay rise we might receive (rather less than huge, we suspect). I filled a happy half hour being questioned by my colleagues on the difference between RPI, CPI, RPIX, the CBI, the FBI, and even the CIA.

The RPI offers us the most hope - it measures inflation as higher than CPI, as the latter ignores mortgage repayments and other costs associated with the housing sector - but the real question which has bothered me of late is the combination of slowing demand growth in economies such as the UK (a major symptom being a stalling housing market) and continued inflationary pressure. In other economies such as Australia and China, inflation is the result of booming production and sales - although both economies (and many commentators) are still concerned about the impact of these increases in costs and prices.

But in the UK and the USA there are genuine fears over stagflation - the combination of stagnant growth and rising prices. This can be shown most dramatically on a Misery Index, which adds the inflation rate to the unemployment rate. The Misery Index for the UK has hovered below 8% in recent years (contrast this with figures close to 30% in the 1970s) and genuinely seriously stagflation seems remote. But the policy restrictions it brings (lowering interest rates to boost growth and confidence fuels higher prices, yet higher interest rates to counter inflationary pressure will damage growth) are very real - in particular for a Monetary Policy Committee who are briefed to control inflation as a primary objective.

The key question could be: can cost-push inflation (a supply-side issue) be tackled effectively by changes in the base rate (a demand management policy)?

The interest rate decision announced this week may provide a clearer picture, but perhaps like British Rail and snow, maybe what the MPC are dreading this winter is the wrong kind of inflation on the tracks.