In his analysis of recent inflation figures.  His ditto-heads, below, all expect to see massive price hikes and can’t understand why it will come down again. (A lot of the right wing blogosphere actively fantasizes about 1980, I am sure).   They should google “base effects”.  As Daniel Pimlott of the FT points out:

the sharp increase in inflation has more to do with the plummeting price of petrol a year ago at the height of the financial crisis rather than unexpected price rises last month.  Although petrol prices rose by a relatively modest three pence a litre last month to £1.08, the year before – at the height of the economic crisis – petrol prices fell by 9p to 95p. The comparison with generally lower fuel and lubricants costs a year ago added 0.5 percentage points to the CPI over the month.

This sort of basic maths is clearly beyond the Daily Mail, who are redefining the word “surge”.  It is beyond the ability of the ditto heads beneath John Redwood’s blog.  But he, as a bright man, and leading contender from a very short shortlist to be the best (very) right-leaning economics commentator on the web, ought to know better.  And a bright man like him ought to know what soaring inflation in the UK really looks like.  After all, he was in power the last time it really happened.

UPDATE: If he wants to know about Galactic hyperinflation, this post from Marginal Revolution tells us.

From the same FT story, “JPMorgan is predicting that inflation will hit a peak of 3.5 per cent in January, before slipping back to experience an extended period under 2 per cent that could last until mid-2011”. This is undoubtedly to do with the output gap that is expected to persist.  But there ARE two risks.  The first is unconnected to this month’s ‘surge’.  One is that the output gap is not as big as people think.  That would be very poor news. As Seeking Alpha observe, some basic causes of inflation have been awakening – input prices for manufacturers, for example.

The other major problem , as Simon Ward of Henderson puts it on his must-read-for-money blog, is that “there is a risk that sharply higher headline rates will destabilise inflationary expectations in the absence of any policy response. With fiscal plans widely judged to lack credibility, the UK can ill afford any loss of confidence in the Bank’s inflation-fighting determination.” Even though the surge is largely a statistical artifact, lots of Redwood-Mail headlines won’t help here.

We would be in the worst of all worlds if we started hitting inflationary speed bumps with the economy so depressed.  I would be amazed if it happened.  The idea that we might have to exit Quantitative easing with unemployment still due to hit 3 million (post fiscal austerity) is scary, and improbable: surely, with those levels of idle capacity, noone can be under much pressure to jack up prices or wages?

On the subject of exit strategies, the excellent Krishna Gua has a discussion of the Fed’s options.

And George Trefgarne maintains a longrunning argument with Congdon about the dangers of QE, in the FT’s letters section:

“[Soaring assets don’t feature in the money supply] But surely the point is that they could very easily be monetised at which point the money supply would accelerate sharply indeed. They are therefore early indications of the inflationary risks that QE is building up in the system. QE has been used in the past – in 1797, 1825 and 1914 – and on two occasions it did indeed lead to inflation”

I am trying to work this out.  Money is printed.  It is used to buy assets, not spend.  Inflation remains weak.  Asset prices are high: the total stock of wealth soars.  Then, suddenly, the assets are monetized, and we get massive inflation.  Presumeably, when the assets are monetized, banks lend against them: because if one party uses money to buy assets from another party, no extra money is being produced?  Help me out here.


12 thoughts on “John Redwood redefines the word “soaring”

  1. “Presumeably, when the assets are monetized, banks lend against them: because if one party uses money to buy assets from another party, no extra money is being produced?”

    Very good point! But isn’t there a legitimate worry that the broad money supply may surge once banks regain their appetite to lend? After all, the Bank of England only controls the narrow money supply (which it has been increasing through QE). Usually broad money supply is a multiple of narrow money supply, but because of the crisis reducing banks’ willingness to lend broad money has instead been shrinking.

    It strikes me that if we return to the old “fair weather” relationship between narrow and broad money then there will have to be a big surge in broad money supply, which could stoke inflation. It all depends on how quickly banks start to lend again; given the state of most British banks’ loan books do you think they are more likely to be very slow to return to old rates of lending?

  2. Yes – it is about banking. But there are many determinants of a bank’s lending, not least capital restrictions, demand for the loans, and government regulation which I suspect will be rather alert in the next few years. Insufficient reserves are a possible limitation factor, but not the only one. So I don’t think that fair weather relationship is particularly meaningful.

    See the Gua story today:

    “But the Fed leadership does not think reserves have a unique role in the inflation process. So it will probably end up draining reserves only to the degree necessary to buttress its favoured new tool: the ability to pay interest on bank reserves and thereby put a floor under the Fed funds rate.”

  3. Good. I’d hate to see the return of inflation. As for reserves, do you think the Bank of England should charge a negative interest rate on banks’ reserves (i.e. charge them for the security of having money in a BoE account), given that banks seem to be hoarding most of the QE money rather than lending it (or even buying assets)?

  4. I think, politically, it might be suicide. “Savers savaged” headlines. Seriously, if objective macroeconomists were to work out that we *need* rates of minus 4%, i.e. for money to become less valuable in your hands, the outcry from savers, pensioners and hoarders would be immense.

  5. And presumably, when you borrow money under negative interest rates, you have to pay back less than what you borrowed. No way would that work. That’s what the liquidity trap idea is for. It wouldn’t be a trap if you could just use negative interest rates to get out of it.

  6. I also think the idea that if the “INFLATION ZOMG!” side shouts loudest in this argument, then it becomes a self-fulfilling prophecy, and we thus get inflation, scares the hell out of me.

  7. I was thinking a small negative interest rate on reserve accounts only, something like the 0.25% that the Swedish Central Bank charges. And it would hardly savage savers – the idea is to encourage banks to invest in productive assets. (The base rate would still be positive.) That said, according to the Swedish Central Bank “the negative deposit rate has not affected how much money the banks have deposited with the Riksbank”, so perhaps it wouldn’t work.

  8. Excellent blog site!

    Regarding the -ve interest rate idea, what effect would -ve central bank rates have on the rates given to savers holding their assets with private banks? Surely they would not actually be charged for holding cash – if that were the case then I’m sure that many would rather withdraw their cash and stash it under the mattress. What would be the knock on effect of this?

  9. Tim, that compliment deserves a reply.

    You are right. Some of the ideas proposed on Mankiw and Sumner’s sites include money ‘destroying’ itself, basis its serial numbers, to prevent hoarding. As a liberal I see this as producing huge invasive problems. People would buy gold, or furniture. They might buy goods and so forth, in which case it will do its jobs. But politically- impossible. I prefer us doing other stuff with QE money, than devaluing people’s cash, for those reasons.

  10. A very interesting analysis. I will not comment further but have made a note in my diary to revisit this site (if it is still running) in one year to assess the voracity of your ideas. If they are proven wrong by the passage of time, I do hope you will not fall back on “it’s all George Osborne’s fault” If they are proven right however, I will raise a glass to you (if I can still afford it, having bought into several asset classes rather than holding much cash)

    Would you permit me to make one request? I disagree with Mr Redwood on many issues, so please, calling me and many of the others “ditto heads” is just pointlessly pejorative, may I suggest “contributor”

  11. Stuart

    Apologies for any offence caused there. I obviously refer only to those who just cheer views they like to agree with. Implicitly, it excluded thoughtful people.

    I like to be honest about my mistakes, so I will not duck the fact if I am wrong. This is not so much a prediction of deflation, as a disagreement about the range of possibilities . . ..

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