Tuesday, January 18, 2011

Inflation Higher

The Office for National Statistics releases data on inflation month by month. We talked a little about inflation yesterday, and will go into much greater detail next week: Inflation is the change in the price level. That's a wonderfully vague definition which you'll have to improve on a little for assignments and the final exam. What price level? Whose price level?

The ONS calculates a number of price indices: Numbers that reflect the level of prices for a collection (or bundle or basket) of goods. Inflation then, according to one of these indices, is the change, year-on-year. So the number announced today was the increase in prices in December 2010 relative to December 2009. We compare year-on-year to account for seasonal patterns that might distort our understanding of what's going on in the economy. Whichever way you look at it, inflation is high.

The Bank of England is set a target of 2% for inflation, yet it was nearly 4%. This creates problems for the Bank of England because inflation is relatively high, yet GDP growth is still fairly embryonic after the recession. Any attempt to curtail inflation by the Bank of England will put downward pressure on economic growth, and hence would not be helpful.

Yet the longer inflation remains higher than target, and particularly with the VAT rise that we've just had at the start of 2011, the more it starts to get built into new wage settlements by workers. If workers are paid more, this will likely lead to higher inflation since consumers have more money to spend while supply levels haven't adjusted.

More next week...

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