Many central banks now have “inflation targets” that they are required to meet, and such targets are set by the government. For the Bank of England, this target is 2%, and is based on the Consumer Price Index (CPI). Some central banks have other legally set targets, such as employment. In the case of the BoE, it has set its own employment targets but these are not legally binding.
From the bank’s own words:
The inflation target of 2% is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI). The remit is not to achieve the lowest possible inflation rate. Inflation below the target of 2% is judged to be just as bad as inflation above the target. The inflation target is therefore symmetrical.
If the target is missed by more than 1 percentage point on either side – i.e. if the annual rate of CPI inflation is more than 3% or less than 1% – the Governor of the Bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target.
This means that the Bank is legally required to do all within its power to ensure that prices rise by 2% a year. Its important to note that this target is not that it must increase the money supply by 2% a year, but that prices must rise by 2% a year. With all the current talk of a “cost of living crisis”, we ought to examine the Bank’s role in causing that crisis. This is gradually making millions of people poorer. Pensioners, and those on fixed incomes are hardest hit. Not everyone is lucky enough to get a pay rise, and those who do often get pitiful raises that are less than CPI. Why is it the official policy of our central bank to make millions of people worse off each year?
Of course, the CPI leaves out key aspects of people’s spending – the big ones being rent and mortgage payments. RPI, which includes these, tends to be higher than CPI each year. So that 2% figure in the CPI is likely under-reporting the true rise in prices each year. Over the past decade, excepting the time of the financial crash in 2009, RPI was around 1.2 percentage points higher than CPI.
There is a persistent myth amongst Keynesians and monetarists (and clearly the BoE) that deflation is something to fear – and so we must prop up the economy with at least some inflation. One of the arguments put forward regarding the dangers of deflation is that consumers will put off purchases, waiting for tomorrow when the price will be lower. To some degree, this is true. But as consumers we do not wait forever – just witness the success of the computer industry. However, let’s accept the argument for the moment. If this is true, then we can make a similar statement about inflation. Sellers of goods will wait till tomorrow to sell, since prices will be higher – and therefore nothing will ever get sold! Again, sellers do take such things into account, but just like the consumers, sellers want to sell their goods eventually. Curiously enough, those arguing against deflation in this way never make the related argument regarding inflation.
Prices frequently fall, or even plunge in recessions, but the cause and affect needs to be established correctly. The falling prices are a symptom of the recession, not the cause. For more of my thoughts on this, I suggest reading this previous post.
Earlier in the post I asked “Why is it the official policy of our central bank to make millions of people worse off each year?”. Part is the current economic orthodoxy which fears deflation (apoplithorismosphobia for anyone who loves such daft words).
We can’t just blame economists, however. This constant inflation benefits powerful groups in society – and let’s face it, they have more leverage than most academics. As I discussed recently, low interest rates and quantitative easing help to push up share prices. Investors love it! And not just share prices – all sorts of assets not mentioned in the CPI or RPI tend to rise when central banks start easing the money supply. House prices have more than doubled in the past 10 years. And let’s not forget the politicians themselves, who are quite happy to keep the printing presses going to help pay off the massive pile of debt they ran up at our expense.