Today the good news on CPI inflation kept coming.  For now we are stuck with the inflation remit, which means that this is the most important news of the month. Nominal demand is overwhelmingly the most important variable for our economy. Most of what you care about is badly affected by it.  The Bank of England drives nominal demand. It does so according to whether it thinks it will hit a CPI target.  This lower print helps.  But what helps even more (I hope) is the Bank learning that higher NGDP growth does not cause CPI to rocket.  The last 15 months have been strong proof of this optimistic thesis. 

This is why the Bank is so interested in productivity; as they put it in their Quarterly Bulletin (hat tip, the FT’s Emily Cadman), the UK’s productivity is about “the economy’s ability to grow without generating excessive inflationary pressure.”

For the last year and a half, that is exactly what it has been doing. This chart shows the progress of NGDP on the X axis and the CPI print on the Y:

NGDP CPI flatter

My simple regressions suggest that the slope of the curve has flattened from 1.2 in log terms to 0.4.  So, for the first 2 years of the Coalition, if you wanted 3% NGDP growth, you had to have 3.6% CPIY growth. From September 2010 to September 2012, NGDP grew a measly 3.7%, and the CPIY index by 5.8%.  Hence all the talk of “stagflation”.

Now, the slope of that curve suggests that if you want 5% NGDP growth, you can have it with 2% CPIY growth.  The Bank can keep the foot to the pedal.

None of this is to let off the CPI from the serious criticism it deserves.  Any system that fools so many people that we have “stagflation” and that in a worsening economy (update: I mean in 2011) we should raise rates (OECD, Weale, Sentance!) clearly needs looking at.  But for now at least the dodgy compass is pointing the ship in the right direction.

(I suspect that once you dive into the individual components, strip out oddities like the effect of tuition fees and focus on real domestically-driven inflation, you get an even better story.  Similarly if you use a less-inflatable index like the GDP deflator.)



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