Shorthand thinking means that inflation is now simply identified as an increase in prices. This is a dangerous misconception, as higher prices on their own are in fact deflationary. This point was recognised by some commentators when oil prices soared last year: the effect was correctly compared to a tax levied by the oil producers which depressed demand in general.
Higher prices are in fact a symptom of inflation, in the same way as a high temperature is a symptom of fever, not the fever itself. Inflation is fuelled by a rise in incomes and spending—not by higher prices, which are an attempt by the economic body to bring excessive demand back into balance with inadequate supply. Inflation is therefore appropriately tackled by letting prices rise without extra spending power. The weapon of choice—rising interest rates—is defective because it results in higher incomes as well as having some restraining impact on demand: many benefits, including pensions, are directly linked to inflation, as are many pay agreements. So relying on interest rates to squeeze inflation prolongs the process of regaining control and achieves eventual equilibrium only at the cost of pushing prices to higher levels than are necessary.
You don’t cure a fever by plunging the thermometer into cold water.
In high school we had a text about this man deciding to call the chair “table” and the table “window” etc, because he thought there was no reason to follow the general conventions of meaning. Sadly, he found it very difficult to communicate with his fellows. Your argument very much remains me of this. Let’s just define inflation as a “rise in incomes and spending” (often referred to as growth), and call rising prices “deflation” (instead of deflation), and let’s not worry if nobody understands it.
As for the remedies, I’m afraid the argument is not clear at all, even apart from the fact that one doesn’t know which defintion of inflation you use here.
Anaximander resembles his illustrious namesake in getting one thing right (the earth is not supported on the back of any animal) and a possibly more important thing wrong (the earth is not the centre of the universe). If doctors chose to regard a fever as a form of chill and treated it by raising the patient’s temperature, there would be few successful outcomes. Tackling inflation must mean either restraining the gross of spending or increasing disproportionately the supply of goods and services. The latter is a very difficult trick to accomplish in the absence, for example, of a constant supply of very cheap imports from places like China – which, in any case, is likely to cause a balance of payments problem.
Good grief. If Prospect could hire someone who knew his Phillips curve from his Phillips screwdriver this might make a bit more sense. I don’t know why this piece started, what its point is, or how exactly it intends to illuminate readers. HC reads like a ‘Charlie Brooker’s Dictionary of Macroeconomics’. You mean that inflation is caused by excess demand, which is a bit like something getting bigger, which is a bit like ‘inflation’. How does that lexicographical quagmire help us? Please do economics properly. Or at least don’t pretend that you’re trying to and keep printing stuff by Ormerod.
Could your good but grievous correspondent consider descending from his pinnacle of polysyllabic use and let us know which of the following propositions he dissents from - and why.
A1 Rising prices are a symptom of inflation, and not inflation itself.
B1 Raised temperature is a symptom of fever, and not the fever itself.
A2 Rising prices are the natural reaction of an ecomony in an attempt to restore the balance between demand pressures and supply.
B2 A high temperature is the body’s natural attempt to restore equilibrium.
A3 Exclusive reliance on the blunt weapon of interest rates has some counter-productive consequences.
B3 Exclusive reliance on the sharp instruments of amputation is apt to result in overkill.
Raising interest rates in a kneejerk reaction to rising prices also aggravates the growth of incomes and expenditure - particularly when the ‘inflation target’ is based on a measure (CPI) which understates the rise in prices which more fully reflect living costs (RPI). Supplementary measures to curb the growth of income and expenditure are also needed, even though they may be politically unpalatable.
Inflation is conventionally defined as the rate of change of the overall price level. We can agree that this is usually caused by aggregate exceeding aggregate supply. Does Harvey mean that inflation is a symptom of excess demand? If so fine. But to cure excess demand you generally need to cut aggregate demand and interest rate rises are a simple way of doing it.
PPE studies (just a guess??) do not a macroeconomist make. Your first point is not even wrong, HC. Fine, Interest rates do not impact all parts of an economy in the same direction, that’s obvious — but they are the best instrument we have. This is not a trivial point, otherwise I wouldn’t bother to reply. Anyone interested can read this: http://www.bankofengland.co.uk/monetarypolicy/how.htm
My biggest concern is the implication in the title that this is to be a series of ‘Harvey Files’. Please, no more.
Just to try and dispel the confusion. Most economists would have problems with A1. Inflation, let me repeat, is simply the RATE OF CHANGE of the price level. If we observe rising prices we know that inflation must be positive, but until we know how fast prices are rising we don’t know the inflation rate. But the rate of change of prices is inflation, not a symptom of inflation(at least if we stick to conventional definitions. And in any case the Bank of England is worrying about a rise in inflation ie prices going up faster than before.
And if we were going to have a serious discussion about these issues we ought to note that an oil price rise is a relative price change and will benefit oil producers at the expense of oil consumers whether the overall price level rises or falls. It is more like a tax on oil consumers (is that what Harvey meant to say?) with the proceeds distributed to oil producers.
By the way, I guess most parents would also disagree with B1. See also http://en.wikipedia.org/wiki/Fever. Fever is defined as “raised temperature”; of course it is usually a symptom of a disease or infection.
In addition, the analogy you draw between A3 and B3 is completely arbitrary and justified by essentially nothing at all.
Calm down! Surely nobody thinks that prices actually cause an imbalance between supply and demand. They reflect them. Changes in the rate of price increases are of course significant but still a symptom rather than the cause. All I have pointed out is that reliance upon Edward Heath’s quote “single club” of interest rates is in fact double edged if they automatically trigger higher spending power too. That is why they are, in part, counter-productive and need to be supplemented by other measures.
Even more confusion. Interest rates do not trigger higher spending power. A rise in interest rates raises the income of savers by the same amount as it reduces the income of borrowers - there is no net effect on income. The conventional wisdom is that savers have a lower marginal propensity to spend than borrowers, so a redistribution of income to savers will cause a fall in spending.
Not so fast. Of course it is well known that people with savings have a lower propensity to spend. (But it also needs to be remembered that some determined spenders increase their borrowing when their purses are tight) the whole point is that the gross impact of higher interest rates on spending is offset to some extent by increases in spending power – which was my original point.
The conventional way to approach this is to break the effects of an interest rate change into an income and substitution effect. The substitution effect will “always” be to reduce spending. The income effect is different for borrowers and lenders. For borrowers the income effect is negative (unless they switch to lending). For lenders the income effect is positive. The overall effect on aggregate income is zero, so the net overall income effect depends on whether there are differences in behaviour between borrowers and lenders in aggregate. But a rise in interest rates only decreases the income of borrowers by the same amount as it increases the income of lenders. Saying that a rise in interest rates results in higher incomes seems to me misleading at best.