In July UK CPI hit 10.1%. Judging by the excitable media response, including BBC Today inquisitor Mishal Hussein demanding of former Chancellor Sajid Javid, “are you not shocked” as though he must be by BBC command, it seems to have come as a Great Big Surprise. Rising from 9.4% and breaking the double-digit barrier is certainly unwelcome and a significant concern (particularly when July inflation data in the US and Canada decelerated). But a shock? Really? Despite for much of 2021 being complacent to the point of indolence about the burgeoning inflation risk, hit by a tsunami of indisputable prices data since Putin invaded Ukraine, the Bank of England has been forecasting double-digit inflation for some months. Underpinned by the pernicious effect of the household energy price cap mechanism, it forecast a 13.3% rate for October at its most recent policy meeting at the beginning of August. The current rate of inflation is on a trajectory towards that projected rate; 10.1% is merely an inevitable (and unenviable) milestone print on the journey. It might be a horror, but a shock, no.

 

Many in the media also take a perverse position on real wages in the cost-of-living crisis. They decry falling standards of living as prices accelerate and wages fail to keep pace. But were wages to keep up with price inflation, that would simply make matters much worse in the long run, creating an upward vortex in inflationary pressure as businesses seek to recover the rising employment cost to maintain margins and protect profits. You can’t have it both ways.

Curbing inflation requires joined up monetary and fiscal policies 

The Chancellor of the Exchequer and the Governor of the Bank of England directly have zero control and negligible influence over global commodity and energy prices. But they do respectively control domestic fiscal and monetary policies which, for far too long, have both been excessively loose, even before the pandemic. Since 2019, the two global exogenous shocks of Covid and a major war in Europe have undoubtedly complicated matters. But however uncomfortable the truth, as well as through raising interest rates, the only other ways to return the inflationary furies unleashed from Pandora’s economic box are a combination of constraining the money supply, keeping a tight lid on public spending and finding a proportionate path with wages.

 

If the Bank has now begun its monetary tightening policy (interest rates in the UK have been rising since December), it only really gets under way properly in September when it begins reversing quantitative easing by actively selling government bonds from its balance sheet. But fiscally, it remains to be seen whether the political rhetoric of the Tory leadership campaign with both candidates claiming to be the true heir to Thatcher, is matched by real action when whichever of them takes office; in short is either Truss or Sunak really committed to significant public sector reform and imposing tight monetarist discipline on the Treasury and the spending departments (notably aside from defence, as identified by Truss: in the light of significantly increased threat levels from those who would do us harm, defence clearly needs more investment but only after root and branch reform of the notoriously financially incontinent MOD and the way the money is spent and accounted for)?

 

With little more than two years until the next election, time is running out for any such significant change of tack away from the egregious Keynesian policies we have seen since 2017 to make much difference. If on the other hand all we have endured this last month as the Tories indulge (or is it flagellate?) themselves yet again turns out to have been no more substantial than populist soundbite politics, our economic underperformance will be enduring. Time will tell. 

Biden’s “Inflation Reduction Act” 

In the US and now in electioneering mode ahead of the critical mid-term elections in early November, Joe Biden has been hard at work attempting to seduce Congress and the electorate that his government is on top of inflation. Step forward the “Inflation Reduction Act”. It may yet prove to be precisely the opposite. In any case, to be clear, the Act does not set out to reduce inflation as its primary goal. The thrust of the legislation, using as its foundation the severely curtailed infrastructure programme enacted last year, is to deliver Biden’s previously stalled climate change agenda. Tacked on to that are the hollowed-out remnants of what was planned to be his great social reform programme, now focused almost entirely on Obamacare-lite reduced medical health insurance costs to the most vulnerable.  

 

In the 19 months the President has been in office, political victories for Biden’s administration have been as rare as hens’ teeth. Aside from the covid recovery policy which in any case had bi-partisan support before the election, little of note has gone to plan or schedule either with his domestic or foreign policy. Thus, with the mid-terms only three months away, after considerable acrimony last week’s final limping across the line for this bill now officially tagged the “Inflation Reduction Act” was a much-needed shot in the arm for him; even then it relied heavily on much pacifying and sweet-talking of recalcitrant Democrat Senator Joe Manchin and needed the casting vote of Vice President Kamala Harris to see it home. But, as they say, a win is a win however it is won.

 

Given the United States’ troubled and deeply divided political history dealing with climate change and all its ramifications, particularly with national vested interests and competitive positions to defend in oil, gas and coal and heavy-emitting industries, inevitably the media has tended to focus on this most significant element of the Act which was signed in to law this week. The emphasis has been on the incentives to make the transition towards carbon net zero, particularly subsidies for wind, solar and green hydrogen capacity and developing other new clean technologies (while to pacify Manchin, no longer removing fossil and hydrocarbon licenses for new project developments), and for consumers, incentives to switch from gas-guzzlers to electric vehicles with the promise of the necessary charging infrastructure to support them. 

 

The care element of the bill centres on health insurance premiums, trying to make healthcare as accessible and affordable to all in an ‘industry’ (for that is what it is) which costs the wrong side of $3 trillion to maintain. In particular, it extends the premiums subsidies and reliefs which under law would have expired at the end of 2021 by another four years.

Tax and spend 

Total funding of $738bn over 10 years derives from a minimum blanket 15% rate of corporation tax and higher personal taxes levied on the wealthier members of society. And, continuing a long-running Democrat vendetta targeting the proprietary pharmaceutical industry dating all the way back to the Clinton administration when Hillary (though not herself in office) was driving the health agenda, a significant reform to in-patent drug pricing.

 

‘Investments’ total $433 billion over 10 years, $369 billion of which is for climate change. The $64 billion earmarked for health is not in fact investment at all, it is pure benefits/social safety-net expenditure; noting the timing for the health programme’s completion in 2026 and ahead of the next presidential election in November 2027, cynically it is open to the charge of being little more than a political bung. The balance of the sums raised is aimed at reducing the government deficit by a cumulative $305 billion over 10 years.

 

So where in all this is the “Inflation Reduction” element as advertised in the tagline? The claim is highly specious. Moody’s, one of the leading independent international ratings agencies responsible for assessing the creditworthiness of sovereign debt including that of the United States, estimates that compared with doing nothing and projecting out to 2031, the effect of the Act on the inflation rate in that end-date is no more than 0.33% (using an inflation index whose base for consumer prices is a value of 100 in 1982-4, and with a current value today of 284.6, without the Act and all other things being equal, the inflation index in 2031 would be an estimated 360.6; with the Act implemented in full, the estimate is a value of 359.4). The effect is nugatory. 

Inflation forecasting and the risk of economic myopia  

With all due respect to Moody’s and their spreadsheets, the one thing we can say with confidence is that they and virtually every other economist are unlikely to be correct in their projections of inflation a decade hence (forecasting the index to one decimal place for 2031 is endearing given that over the past 12 months most economists’ forecasts for inflation in 2022 have been wrong at least three times, let alone by 10 basis points).
In these musings over the past few months, we have regularly discussed the factors affecting the short-term inflation outlook: volatile commodity prices; Putin weaponizing energy and food markets; OPEC’s reluctance to play ball with Biden over oil supplies; wage pressures; slowing economic growth and the risk of recession. Leaving those aside, longer-term, looking out over the next two or three decades there are big macro forces at work potentially pulling in opposite directions: among those which are deflationary, the next phase of the digital revolution and ageing populations and falling birth rates particularly in the west and China; inflationary pressures include the race for carbon net-zero as virtually every country (all bar three in the world signed the Paris Climate Accord) chases capacity constrained labour, capital and raw materials to replace an almost wholly carbon-based economy and society developed over three centuries with one in which carbon is a pariah in a little under three decades. In addition to all the carbon reduction programmes initiated in Europe in particular and accelerated by environmental conditions put in place in relation to state bailouts for financially vulnerable heavy industries during the pandemic, Biden tipping in an extra near-half trillion dollars of investment as America, substantially the biggest economy in the world, plays catch-up only adds to that pressure.  

Gone fishing 

Next week, the world’s principal central bankers meet for their annual symposium at the fishing resort at Jackson Hole, Wyoming. Used to dispensing monetary writ from on high, but with slipping halos and facing stiff criticism and open to the charge of arrogance and indolence (“asleep at the wheel”) in the face of the obvious inflation risk, one imagines it will be a rather more reflective and introspective meeting than usual. The US and now the UK bond yield curves are uncompromisingly inverted, both pointing towards the markets’ assessment that the aggressive use of interest rates to curb inflation risks running both economies on to the rocks. It is never easy to admit you’re wrong but a little ‘mea culpa’ would go a long way towards helping restore confidence and leadership.

 

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