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Interesting article. Two quick queries that have always puzzled me. Firstly, most pay awards are linked to the inflation index. But to me this appears to have the potential to spiral out of control i.e. inflation increase causes wages to increase, which increases price on goods and services, which increases inflation. How is that controlled?

Secondly, the inflation that we are experiencing at the moment is due to circumstances which I would say are outside the control of the nation, i.e. energy cost. It's taken a little while to see the effects of increase oil price but when we consider that most goods and services rely heavily on energy for production and transport then it's obvious that prices have to rise. Especially so when you consider how much we rely on imports these days. Therefore, my question is: aren't we in a very unstable position financially when our inflation rate is so dependent on factors outside the control of the UK government and banks?

I wondered if Evan thought similar principles apply to house prices? Many of us belive they are over-valued however we keep buying on the basis that there won't be a crash. Will the bank will reduce interest rates to prevent a crash because the damage to confidence and the economy would be so great?
Therefore, will the housing 'crash' be stagnent prices for 10+ years?

Evan, in common with many economics commentaries, you refer to inflation as though it is a rise in prices.
Don't you agree that this is misleading? Inflation of the money supply (through, for example, lowered interest rates) is the true inflation which leads to a fall in the value of each pound and hence a rise in the number of pounds required to buy a given good or service. Looking at the entire cycle reveals the central bank not as the fighter of inflation, but the creator of it.
Also, it would be a great service to your readers if you would find space to reiterate that inflation transfers wealth away from the ignorant and the weak into the hands of the better-informed.

Panic not Evan!

I don't know if you're aware of this but over 1 million local government workers (including myself) are being offered a pay rise of between 1.5 and 2% this year - way below inflation.

Surely that will alter this trend a little. I know my spending will be slowing down...

Pay rises aren't only linked to inflation, but also to productivity growth. The rate of the pay rise should be the rate of expected inflation plus the expected productivity growth. Only if you assume that productivity growth is fairly constant, you can make a judgement on this issue. However, when there are big leaps in technology or investment booms, productivity could grow more quickly for some time.

Dear Evan,

I have a simple question - what is the Bank of England for? I can see that the Bank can set the base line interest rate, which my mortgage provider then incorporates into its mortgage rate, which results (when rates increase) in an increased cost to me. I can also see that there is a claimed justification for doing this. (Higher mortgage rates result in people being able to afford to borrow less, thus suppressing house prices, for example.)
So my question probably becomes - what is the relationship between the Bank of England and the consumer facing financial institutions?

"Inflation is the one form of taxation that can be imposed without legislation." Milton Friedman

Richard, don't discount the free-rider theory. In other words 'ordinary' people free ride on decisions made by the better informed (ie. firms).

Also the contribution of the media; the popular press 'translates' raw economic data into language digestible for the man in the street, thereby making him better informed

Dear Evan,
If more and more old guys like me don't have any mortgages, but do have a bit of savings, then surely a rise in interest rates is not going to bring our spending down. Does the bulge in the older population herald a new economics?

Sorry Stefanie, that does not always hold true.
At the moment Old Brownnose wants to cut civil service jobs by 105,000 but wants the same or more productivity and all for a whacking 2% increase on a pay scale where it is virtually imposible to reach your grade maximum.

I know they must be clever guys at the Bank of England, but they always seem to be a little late. Mind you they could just be a cycle ahead of us.

If they are economists then they are practitioners of a very inexact science, which is probably why the Governor's vote always seems to matter, and they are probably just as lost on this as the general public,

Anyway it seemed to me late last year that people were not spending, and had tightened their belts, Speaking as someone out and about in the retail world. It occurred to me then that what was really worrying people was the cost of fuel.

The cost of fuel for vehicles went up substantially last year, which affected all transport, with all that means for private users as well as business users with all the implications of the transport costs being passed on to the consumer in higher prices.

We have not mentioned the cost of heating oil for the winter which was becoming a worry late last summer.

Fortunately the price of oil dropped and we now seem to pay at least 10p per litre less, and, even though that well known highwayman Gordon Brown stuck us up for 1.5p, it seemed to give people confidence.

The Bank probably know this but you feel that they feel they must interfere because they have to, rather than because they know what they are doing.

Excuse this oversimplification of things, this is my first blog, however I remenber Chancellor Lawsons performance with interest rates nearly 20 years ago. To alot of people he went from clever man to idiot almost overnight.

1) Is it coincidence that it's about 30 years (i.e. about a generation) since a spike in inflation fuelled by a credit boom? Is this a lesson that can only be learned the hard way?

2) This has been nagging at me for a while. For the first time, we have a significant and growing number of people who don't see debt as something to be repaid. This could interact with interest rates in nasty ways. As rates rise, they will at first seem to have less effect on consumer spending than expected. So they will have to rise more than they should need to, damaging capital spending by businesses. As businesses suffer from high rates and lay people off, there could be a sudden wave of personal insolvencies, followed by what could probably be described as a crash....

Hi Evan,

I agree that this is the first major test of the Banks credibility (well certainly for the current Governor), so yes they will be very keen to 'impose' discipline back onto the UK consumer..

But I do think the economy is far more reactive to interest rates that ever before - both actual and expected (given that expected rate rises get built into fixed rate loans). The fact that the UK economy is so highly debt leveraged for both government and individual, means that interest rate increases will quickly feed through to reduced spending/investment - making further rate rises less likely, and the period of higher rates shorter..

I would expect the current wage increases will largely be used to finance debts/mortgages rather then instant spending (lets face it, an instant spending bonanza is only really likely from the city bonus club!).

As I write today there are worrying signs that the global asset bubbles are comming to the end of their run (US/UK stock markets and property prices). In the UK we are seeing some tentative signs that the UK housing market is finally levelling off.

It also seems that there is growing concern that the Bush administration is building up for showdown with Iran (and we all hope it's not a military one), in the last year of his term in office.. It's clear that the consequence of such actions would not just be seen in the price of oil, but also in all makets where confidence is needed.. If this does happen we will be seeing interest rates dropping quickly to soften the recessionary pressures unleashed..

Evan

It's only small comment but I personally have been suffering from 10 years of 'deflationary' pressures. I seem to earn less each year. Am I alone?. There is also the choice of earning 'less' to bring up a family in modest circumstances. The financial savings are often made at practical level i.e grow your own veg, than budget proposals for diminishing english voters. We despair quietly. There is too much wrong to correct in one budget, or even many. Good read though and comments.

Rates are not going to rise because - there will be (I think they'll fall by end of 2007 early 2008)

1. Real cuts in pay

2. Real rises in some key expenses e.g cpuncil tax

3. Falls in energy prices

Ms Allison pointed out a large number of workers in the public sector will get real cuts in pay, moreso once you factor in the tax bite.

Mr Davies should focus on money illusion, anchoring and framing effects so prevalent in Behavioural Economics to explain what is really going on.

However since Brown has anchors us to the lower CPI traget this forms the basis of pay settlements in the public sector which is made worse as headline inflation is much higher and of course he has scrapped the 10% tax band.

How much longer will we tolerate the decline ion the quality of our public services as Brown attempts to present a good set of books which underestimate the full liability of PFI? and not forgetting the contiunued widening of incvome inequality under te Blair Brown partnership