UK Edition
In 1964 central banks thought they'd tamed inflation. They were wrong. Are they again?
Inflation is surging. Living standards are under the cosh. Households are under pressure. This is the current state of play in the UK – inflation is at 3pc and pay growth is sluggish. But by historical standards this is still a very low rate of inflation.
Previous spikes in prices have been much more severe. Inflation peaked at 5.2pc in 2011, 7.5pc in 1991 and more than 24pc in 1975.
The fact that this really rather modest pickup in prices causes such worry reflects trends of the past 25 years.
After chaos and pain in the 1970s and 1980s, price growth has been tamed. Inflation has been vanquished.
The expectation of steady, predictable inflation makes a divergence from that path a surprise, though it also helps inflation return to target by keeping wage and price rises in check.
Indeed this is the case around much of the rich world. The OECD, a club of 35 mainly rich countries, has seen the same pattern. Inflation across its membership (which has expanded over the period) rocketed to more than 14pc in 1974 and again in 1980. Since then it has fallen steadily to 1pc in 2016.
Now central bankers fear inflation is too low, taking unprecedented measures in recent years to stave off deflation. A spell of above-target inflation is not the worry it once was.
Are they right to be so one-sided in their view today? Is inflation truly dead?
We have been here before. Back in 1964 inflation had been tamed. For much of the decade inflation bounced around between 2pc and 4pc, a comfortable, moderate bracket. Demand-side management of the economy was working.
But at the end of the decade, seemingly out of nowhere, it fell apart. In 1969 British inflation broke the 5pc level and by 1971 it stood at more than 9pc. It more than doubled again by 1974. It took long years to work out what had gone wrong and how to fix it.
In terms of economic management, one problem was the use of the Phillips Curve – an analysis and set of policies which led politicians to try to raise inflation as a means of cutting unemployment.
This worked, but only in the short run. In the end, workers kept demanding higher wages to cope with inflation, forcing up prices further and ending in a damaging wage-price spiral, with no extra employment.
Battles with the unions were a linked phenomenon, with organised labour holding chunks of the economy hostage.
And external factors hiked prices too, across the whole rich world – most notably in the form of the oil price shocks, including the oil embargo of 1973 which quadrupled prices and hammered the oil-reliant economies of the West.
Could that happen again?
Circumstances are certainly different now. Monetary policy is run very differently. The economy is far more globalised. New sources of oil have come to the market, lessening the reliance on the Middle East.
But that does not mean we should be complacent.
Certainly few economists currently expect any meaningful uptick in inflation.
UK economic growth is modest, the world economy is performing well but not overheating, and the fall in unemployment in much of the rich world – led by countries such as Britain – does not seem to have led to the rise in wage inflation which one would have expected.
Trade with the emerging economies, particularly China, has helped keep price pressures down.
New technology, too, has cut costs.
What are the risks?
There is still potential for inflation to rise in certain circumstances, however unlikely it might feel today.
Howard Archer, chief economic adviser to the EY Item Club, says we should not be too complacent.
“Things don't last forever,” he says. “I can’t see anything now that would push up inflation, but 20 years ago you’d have been surprised that inflation could be so low for as long as it has been now. Who isn’t to say that we could be worried about inflation being too high in, say, 10 years’ time?”
External risks are unavoidable. Sterling could take another tumble, for example, or the price of oil or other commodities could shoot upwards.
Domestic policies, too, could take a turn for the worse.
“Bad economic policies can always lead to inflation, and that is still true,” says economist Kallum Pickering at Berenberg Bank, though he too expects inflation to remain low for the foreseeable future.
Excessively loose monetary policy could force inflation up, he notes, as could prolonged and uncontrolled budget deficits.
If trade unions returned to power, which is not beyond the realms of imagination given current political conditions, it could lead to a wage-price spiral taking hold.
Perhaps more subtly, faith in the current monetary arrangements could be undermined.
After the financial crisis the Bank of England was given far more powers to oversee the banking sector, in part confidence in the institution was high as it had a reputation for hitting the inflation target.
Pickering fears these extra powers could end up harming confidence in central banks’ ability to keep inflation steady.
“When it comes to monetary policy, you can achieve credibility by being successful,” he says.
“When it comes to financial stability, does the market pat the Bank on the back for the bubbles that don’t happen and the risks that don’t happen? No it does not. Eventually on financial stability oversight the Bank will fail – it is almost certainly going to happen at some point, to even the most vigilant regulator.”
If and when that takes place, it could undermine faith in the central bank overall, harming its ability to keep inflation on target too.
However it happens, one day inflation will be back, Pickering believes: “Inflation isn’t dead and it never will be.”