When Covid infection rates dip, inflation rates may well rise | Business

Andy Haldane caused quite a stir this month when he suggested the economy was like a coiled spring waiting to go off. As the Bank of England’s chief economist has discovered, it’s harder to be a Tigger than an Eeyore. Predictions of impending disaster tend to be forgotten even when they don’t come true. Much less slack is given to those predicting that things will turn out well.

Haldane could well be proved right. Consumer and business confidence is on the rise and if – a big if, admittedly – the government continues to support the hardest-hit sectors appropriately as the economy is unshackled, it is quite possible there will be an explosion of pent-up demand.


What is inflation and why does it matter?


Inflation is when prices rise. Deflation is the opposite – price decreases over time – but inflation is far more common.

If inflation is 10%, then a £50 pair of shoes will cost £55 in a year’s time and £60.50 a year after that.

Inflation eats away at the value of wages and savings – if you earn 10% on your savings but inflation is 10%, the real rate of interest on your pot is actually 0%.

A relatively new phenomenon, inflation has become a real worry for governments since the 1960s.

As a rule of thumb, times of high inflation are good for borrowers and bad for investors.

Mortgages are a good example of how borrowing can be advantageous – annual inflation of 10% over seven years halves the real value of a mortgage.

On the other hand, pensioners, who depend on a fixed income, watch the value of their assets erode.

The government’s preferred measure of inflation, and the one the Bank of England takes into account when setting interest rates, is the consumer price index (CPI).

The retail prices index (RPI) is often used in wage negotiations.

But even if Haldane is wrong, it’s important to have people making the upbeat case. It would be a much greater cause for concern if all nine members of the Bank’s monetary policy committee (MPC) thought the same way.

The dangers of groupthink were well illustrated by the financial crisis of 2008-09. Central bankers, investment bankers, the International Monetary Fund and most of the media believed that liberalisation of the financial system had made it safer, when the opposite was the case.

Warning signs from the US housing market were ignored. Dangerous levels of risk-taking was permitted. All sorts of nonsense was peddled about how sophisticated financial instruments that few actually understood would make everybody better off. There was a collective failure to recognise that something could go seriously wrong with a supposedly foolproof model. Eventually it was recognised that herd mentality had led to the near-implosion of the banking system, but only after the event.

The MPC’s maverick voice back then was David Blanchflower, who called for much tougher action to deal with the looming crisis. He got it right.

Currently, there is quite a lively debate among MPC members about what is likely…

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