Catch 22
A couple of not very encouraging pieces of macroeconomic news have hit the UK in the past few days. Yesterday it was revealed that inflation - already way above the target of two percent, had unexpectedly jumped from 3.3 to 3.7 percent. Our inflation is now the highest of any developed country.
Today the Office of National Statistics announced that the employment rate for the quarter ending in November 2010 fell by 0.3 percent, with youth unemployment now at a record high.
With economics very much at the forefront of political debate these days, anyone with a political vested interest has jumped on the figures as affirmation of their positions.
"It's no surprise that the job loss totals are creeping up," said Dave Prentice of public sector union Unison. "The coalition's policies are poisonous for our recovery, and risk a downward spiral for our economy... Meanwhile it's easy street for the bankers who caused this crisis, and are still making off with billions in bonuses."
Of course it doesn't suit Prentice, or the public sector workers he represents, to acknowledge the greater threat to the entire country faced by its debt burden. But his rabble-rousing did yield, presumably by accident, some insight: "It's misery for families, hit with a toxic cocktail of high inflation which is pricing them out of everyday living, and dwindling job opportunities."
The term ‘stagflation' was coined in the States in the 70s to describe the Catch 22 situation of coexisting economic stagnation (as defined by high unemployment) and high inflation. The reason this is such a big problem is that the short-term measures available to boost economic activity are, by definition, inflationary.
In theory stagflation isn't supposed to be possible, because high unemployment should be deflationary as people and companies spend less money. So much for theory, but the question is: what can and will be done about it?
"Sky high consumer price inflation coupled with subdued wage inflation and falling employment means that household real incomes are being squeezed," said Alan Clarke, UK economist at BNP Paribas. "This reaffirms our belief that consumer spending growth will be much weaker than consensus expectations this year."
The Bank of England was under pressure to raise interest rates yesterday on the back of the inflation increase, but that clamour will be subdued by these unemployment figures. This neatly encapsulates the dilemma faced by policy-makers in a time of stagflation: do you address inflation or economic activity?
Right now, despite the fact that its core remit is supposed to be to keep inflation around two percent, the BoE still favours loose monetary policy for fear of damaging the recovery. In the public letter to the Chancellor that he's is obliged to write when inflation tops three percent, Mervyn King will say transient external factors such as global commodity prices are to blame for the high inflation.
But he's been using that argument for a while, and you have to wonder how long it will be before King admits the high inflation is due to interest rates being the lowest they've ever been for the past two years. When he does, especially if GDP is on the rise too, we wouldn't be surprised to see interest rates climbing rapidly.
