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From The Times

June 19, 2008

The economy: it's not as bad as the Sixties

We have dealt with inflation before - and if we learn the lessons of the past we can do so again

Anatole Kaletsky

To the naked eye, there is no perceptible difference between a 3.3 per cent and a 3 per cent rate of inflation. Why, then, all the fuss about a “cost of living spiral”, as the latest mini-crisis to hit the Brown Government was described yesterday on the front page of The Times?

This question invites three right answers and one wrong one. The wrong answer is the one most widely heard among saloon-bar cognoscenti: that Britain is finally paying the price for a decade of living beyond its means, of excessive borrowing and spending by consumers, homeowners and government.

Comparisons are suddenly being drawn with the late 1960s and 1970s, when economic growth stagnated while inflation climbed inexorably higher. It has even been claimed that inflation today is exactly the same as it was in 1965, when Iain Macleod coined the word “stagflation” to describe the miserable combination of stagnation and accelerating prices.

But comparisons with the stagflation of the 1960s and 1970s are wrong because the main causes of that period's economic crises are not present today. There is no overweening trade union movement, no national obsession with protecting inefficient and dying industries against international competition and no totemic faith in fixed exchange rates between the pound and the dollar or the German mark.

The most important difference, however, is in the attitude to inflation among economic policymakers and politicians.

After the 20 years of almost uninterrupted economic crises that began in the late 1960s, there is a universal recognition that inflation is extremely damaging not only to financial stability but also to growth and employment and that it is very costly to reverse once it gets out of hand. There is also an understanding that inflation is primarily a monetary phenomenon that needs to be tackled through interest rate decisions by the Bank of England that affect the entire economy, rather than the panoply of meddlesome micro-level initiatives - price controls, wage controls, import controls, credit controls and exchange controls - that turned out to be not just futile but counterproductive in the 1960s and 1970s, adding to rather than overcoming inflationary pressures.

This greater awareness and understanding of inflation leads, of course, to the justifiable reasons for people to be concerned, though not alarmed or panicked, about the recent inflation figures. The first is that the new monetary regime created by Gordon Brown in 1997 is now facing its most serious test to date - and should this test end in failure, we really will have to dust off our history books of the stagflation period.

The key features of this new regime was the Bank of England's independent authority to set monetary policy so as to keep inflation as close as possible to a 2 per cent target. Nobody expected this target to be hit all the time, but the Governor was required to write a letter of explanation whenever inflation deviated from the target by more than one percentage point - which happened on Tuesday for only the second time since 1997. With the Governor now predicting that inflation will stay well above 3 per cent for most of the rest of the year, the burden of proof is now on the Bank to persuade the public, the media and the financial markets that monetary policy really is appropriate today to ensure that inflation returns to the 2 per cent target by next year. With inflation likely to keep rising for the next few months because of soaring oil prices, the Bank will have a hard task persuading people that it has the situation under control.

The Bank believes that a 5 per cent interest rate is already high enough to return inflation to its target - and I believe this too. But this judgment could turn out to be wrong - and if so the Bank will have to be step firmly on the economic brakes, regardless of the pain this may inflict on the economy and a housing market already in trouble. Such a tightening of the monetary tourniquet is not, in my view, very likely - but it is a possibility in the months ahead and Britain should be braced for this risk.

The second genuine reason to worry about the inflation figures is the challenge they pose to the Government. Will Gordon Brown withstand demands for public sector pay increases to compensate for the rising cost of living? If he gave in to such demands, the result really could be a 1970s-style wage-price spiral. Alternatively - and more probably - the Bank of England would respond to spiralling wages by sharply increasing interest rates. That, in turn, would trigger a deep recession and mass unemployment more reminiscent of the Thatcherite 1980s and 1990s than the 1960s and 1970s.

From this standpoint, probably the biggest worry has been Mr Brown's surprising combination of weakness and short-termism since he became Prime Minister. If he responds to minor hiccups such as the 10p tax row by giving away £2.7 billion, one wonders how he would react to a genuine challenge to his authority on the scale of the Winter of Discontent?

The season of escalating pay demands now likely to hit the Government brings us to the third genuine reason for worrying about the latest inflation figures: the accelerating increase in prices does represent a genuine reduction in all our living standards. That this burst of inflation has been caused mainly by rising oil and commodity bills should make it clear that a transfer of wealth is happening on a global scale. Commodity consuming countries such as Britain have enjoyed enormous gains in their living standards over the past 20 years, partly as a result of falling prices for oil, food and other commodities which we import. Now some of those gains are being recouped by commodity-producing countries.

Britain should, of course, try as hard as possible to reverse some of the recent increase in commodity prices, especially by taking tougher measures to reduce oil demand.

Beyond that, however, the best thing for Britain to do is to grin and bear it, accepting a small sacrifice in the standard of living. The decline in Britain's living standards caused by this shift in relative prices is likely to be a very small one compared with the big gains achieved since the early 1990s.

This, remember, is a period in which Britain overtook first Italy, then France and finally Germany and Japan in terms of national income per head. None of these relative gains will be lost if Britain's living standards decline slightly as a result of rising commodity prices, since other advanced economies are hit just as hard. If we lose control of inflation, by contrast, all Britain's economic achievements of the past two decades will turn to dust.

When can someone do something to change the system where the public sector gets indexed pensions which we all have to pay for where as the private sector struggles to provide for their retirement and is left having to look for means tested benefits to keep to survive?

P Bray, Hereford, Herefs

I find it extraordinary that mainstream commentators fail to talk about money supply when discussing inflation. Zimbabwe's annual inflation rate is 100,000% because its government prints money. Western govt's and central banks do something similar with budget deficits and open market operations.

George Thompson, Croydon, U.K.

Energy bill's are to rise by 40% this winter due to rising oil price's, are our wage's to rise too, i don't think so!
It's hitting us hard and it's hard to stay positive in this rocky economic climate. Check out this fantasy goverment website, www.uk-gov.org.uk , have your say.

celia, lincolnshire, uk

Anatole,
You are wrong when you say " no national obsession with protecting inefficient and dying industries".. there is one that has been protected, the excess of useless Government employees.
Why has the civil service never been trimmed to reduce costs (taxes) in order to match that of UK firms?

Dave Andrews, Glasgow, UK

MGrelton" --accept a lower living standard? How when they and the Govt are hocked up with debt? They cannot afford higher inflation, "
You think there is choice? No. If imports cost more we are worse off, on average. NO policy can stop that. Protecting some(e.g. tanker drivers) MUST harm others.

RobSlack, London, UK

I'm not sure you, Mr Kaletsky, are old enough to remember the 1970s let alone the 1960s. You could only have been in short trousers when Harold Wilson didn't devalue the pounds in our pockets.

Unlike today Britain was full of confidence. We had the Beatles, love, peace and shillings.

Adrian Gilbert, Tonbridge,

Having spent many years living in France and Germany, I can say with confidence that the standard of living in the UK is considerably lower. To believe economists's figures which state otherwise is, quite frankly, naive.

Stephen, London,

I'd be more willing to accept the pain that price inflation is causing if those who benefited most from the situaion that cased the problem (let's say bankers and MPs) weren't somehow excepted from the 'exhorbitant wage increases case inflation' rule.

I'll take my hit after they take theirs.

Mike, Reading,

"no national obsession with protecting inefficient and dying industries"

This if nothing else in your column is laughable. It is the STATE which has grown obscenely since the 60s, and it protecting this bloated inefficient enterprise which is obsessing the labour party and parts of the country

Mark, Ascot,

Mr Kalensky, what about doubling the tax on petrol, then using the proceeds to reduce income tax. This would squeeze demand for petrol and thereby slow down the transfer of wealth you mention above.

Desmond, London W11,

Why Oil Prices Are So High?

Check the link

http://www.alternet.org/workplace/87474/

roland deschain, cheltenham,

George from Exeter has the measure of things......quality of life in Britain is zero.Its not all about money-quality of life in some poorer countries eg Greece is actually ten times better than here.

antony Graham, southport, England

You're right, now doesn't compare one bit to how it was in the 70's. The 70's with it's high inflation, three day weeks, petrol shortages etc was a doddle compared with now. As a young worker on a pittance in those days life was actually fun and there was hope. Now there is nothing.

Nigel, Lincoln,

Thank you for discussing the REAL issue; inflation.

I am assuming that it is politically and socially 'inconvenient' to challenge the validity and accuracy of the G8 inflation numbers ?

Now there's a story...bs inflation = bs economic stats. And hey presto, the emperor has no clothes.

Derek, Cape Town, South Africa

Artificial wealth (house prices), artificial economics (massive amounts of credit debt), and artificial employment (the majority in the service industries or public sectors rather than production and export). It couldn't go on for ever could it?

Jason Wells, London, UK

How can you say that inflation is only 3.3% when diesel goes up 2p/l every week.

Jonathan Bryce, Reading, Berkshire

Funny how economists like anatole like to think 3.3% is even close to reality. Inflation is way higher and so interest rates should be far higher to contain it. So real interest rates are still very low and inflation will accelerate. Except house prices, which will correct back down 3-4x incomes.

Adam, London, UK

All this is a redistrubution operation: Income will shift from non-oil selling activities to oil-related companies and fortunes. JR Ewing get a bigget piece of the pie, the man in the street that doesn't own BP shares ends up with a smaller portion.

Inflation is just the means to that adjustment.

Rui, Lisbon, Portugal

Along with this inflation and relative price reorganization some will try to smuggle in their own interests, revising relative prices in their favour.
Not to properly adjust wages for the inflation that already exists is one such plot: this shifts income from wage earners to profit earners.

Rui, Lisbon, Portugal

He who manipulates the oil market controls all commodity prices, inflation and interest rates. So stop looking at the effects, deal with the cause. Address the market manipulation of oil production, supply, refining, trading and all the (frontmen) being the investment banks, hedge funds.

Will, Lincoln, UK

Anatole lost his credibility as an economic commentator when he wrote in 2006 that the best remedy for the German economy was to engineer a housing boom along the lines of Spain and Ireland.

W McMordie, London, UK

All political commentators keep harping on about the high unemployment figures of the Thatcher years, nothing has changed we have millions now on wefare of every type they
conjure up. At least in the past unemployment figures were
correct now we have endless lies and higher taxes.

sam watts, budleigh salterton, devon

Learning lessons from the past pre-supposes that a labour controlled government can and has learnt that boom follows bust.This is the third Labour government in recent years repeating the errors of the last two.Problem with your theory is we are already on the skids. 4th time lucky? anyone

philip, Ipswich,

Until this point it felt cheaper and happier to buy and insure a car, than take the train. If only rail travel were the cheap substitute it should be, there surely there would be lots more smiles on faces? I hear many of them don't run on oil, can fit lots of passengers, and are extremely popular!

Jonathan, Baldock, UK

Let's make it clear when we're talking about inflation you're talking about the new measure CPI.

RPI is 4.3% already and I suspect most people don't believe this as the price rises they see on a day-to-day basis are much higher than this

Andy Davies, Glos, UK,

I think every one is all to ready to start spouting doom and gloom with regards to the economy. We have gorged ourselves for to long and now its time to go on that diet. Times will be hard but not as hard as in previous cycles. We should consider long term and not allways look for the quick fix.

Michael Whitney, London, UK

Oh come on- we now rely on a a 'creative' economy heavily dependent upon financial services, property, and debt being recycled to keep the economy working. High inflation and short credit will pre-empt a vicious trend in our economy and we have no manufacturing sector to fall back on for relief.

Darren Pipe, Greenhithe, Kent, U.K

I would really like to understand how they measure inflation...in 10 years- house prices have rocketed, coucil tax doubled, petrol/gas etc doubled (much of it to this point tax..) food is now well over 5% and more...parking, road tax, .then we look at everything else Gordon put tax on-it's way more

phil, Headley Down, UK

Chris K, Cheltenham - and essentials like house price INFLATION. If any business ran their books with such important factors 'off-balance-sheet' they'd be in the dock for fraud. And the capital reserve banking system is no other than legalized fraud (the ability to create money).

Michael, London, England

Disproportionate taxes that stifle growth, a bloated public sector that is living a fat cat life style compared to the private sector and a weak PM and chancellor: we have much to concern us. We cannot affect the price of commodities. We can reduce the public sector, taxes, and fighting wars.

Karen , London, uk

For the record, I think that the price of oil in the short term is a bubble caused by speculation(along with all the other commodities). Yes those prices will go up in the long term as well... but what's happening now is not due to supply and demand.

Jeremiah1974, London,

It's like watching a slow car crash and Ground Hog Day all at the same time. Brown resist the unions? Unlikely. And get away with it if he tries? Not a hope.
Tighten your wallets for a seriously bumpy ride.

Ian Campbell, Truro, England

Food and fuel inflation is hitting those on the lowest incomes very hard and the wealthy, business representatives and indeed the government are all starting to sound like Marie Antoinette when asking for the little people to show restraint in their pay demands.

Clive Stringer, Eggesford, England

The only measure this thieving government is likely to take to reduce oil demand is to increase fuel tax.

Increased fuel tax = increased fuel cost = inflation.

Sounds counterproductive to me.

Redcliffe, London,

'This, remember, is a period in which Britain overtook first Italy, then France and finally Germany and Japan in terms of national income per head.'

And this also a period when wages may have increased by 22%, but consumer borrowing has rocketed by nearly 68%. It really IS 'different this time'..

Darren Pipe, Greenhithe, Kent, U.K

Public sector workers are the last remnants of the pre Thatcher industrial era. They don't get layed off, they expect inflation proof pay rises, they have gold plated pensions. They are the albatros round the neck of the economy and Brown must reduce, in real terms, their pay and numbers.

Jason White, Paris,

Fiscal bulimia by Government doesn't exactly help, though, does it? Big budget deficits help drive inflation and heavy, rising taxation discourages growth - anyone disagree?

Frank Upton, Solihull,

There is indeed little difference between 3% and 3.3% inflation - if that was the true figure. Unfortunately out here in reality the rate is significantly higher.

Perhaps someone in authority could explain why the official figure seems to ignore core essentials like food and fuel?

Chris K, Cheltenham, UK

During the 80's and 90's Britain was not importing oil, in fact most of the wealth we currently have originated from the revenue resulting from North Sea oil production.

This time around we have no oil left to maintain govt revenue and expenditure. The recession will be far worse.

Toby, Winchester, UK

Where there is a mismatch between supply and demand such that inflation results, reducing demand through higher interest rates is the only remedy. Belt tightening awaits.

Arnold Ward, Weybridge, Surrey, UK

Why these half baked comparisons on National income per head. ? Germany has excellent public health and transport systems,low level of public/government indebtness,and much more social cohesion.Only country with which China has a trade deficit . Quality of life is what counts not quantity.

George, Exeter, UK

Corr, I really do not know why I bother reading this person as he has not a clue. People accept a lower living standard? How when they and the Govt are hocked up with debt? They cannot afford higher inflation, they will demand more money. Strikes and discontent are coming.

MGrelton, London, UK

"taking tougher measures to reduce oil demand".
The reason prices are going up is the price of fuel and transport costs . Most of fuel costs go to the Treasury. Were they not so rapacious the cost of fuel could be reduced which would reduce transport costs and inflation.
And pigs might fly.

Bernard, Edinburgh, Scotland

Excuse me, Bob of Sevenoaks, but did you fill up the car this week? Did you present Pounds? Did they give you petrol in exchange? Did you realise you can buy Gold with those Pounds if you so choose?

jon livesey, Sunnyvale, CA/USA

What is a lot different between now and the 70s is that everyone is much more aware of the cost of living spiral than then.
Does anyone really care about silly league tables of national income per head when your personal experience is that things you spend your wage on are rocketing in price.

rick, sydney,

If you can remember the '60's you weren't there.

Andrew Milner, Karuizawa, Japan

The fact is that inflation is way over 3% - continual discounting of factors in the equation like food, fuel and housing (ie the things that are actually going up), only serves to highlight the blatant con-job that this Government is trying to perpetrate.

I'd be amazed if it was really under 15%.

Paul Chenery, London,

Learn from our past mistakes. Ha ha ha ha ha ha.
Another person who actually thinks our Fiat money is still worth something. How quaint.

Bob, Sevenoaks, UK

Truth is no one knows how bad inflation is going to get the government is living on hope!Only this week the USDA has reduced the estimate of the current US corn crop by 10% due to severe rain in the mid west.And now UK gas is going up 40%!

David Vinter, Louth, Lincs., UK.

Contrast with Buiter's piece yesterday. Those inflation nutters cost us 0.5% a year growth for about six years. That lost wealth is equal to twice the defence budget now. Imported commodity price rises are deflationary. 1st round responses (tanker drivers) redistribute. 2nd round is the test.

Peter Dunford, Dorchester, UK

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Anatole Kaletsky

Anatole Kaletsky writes for The Times Comment pages on Thursdays. One of the country's leading commentators on economics, he was formerly Economics Editor and is now an Associate Editor of The Times. He has won many awards for his financial and political journalism. Before joining The Times, he worked for 12 years on the Financial Times

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Fighting Fit

Navigation - link to other main sections from here

The FA is no longer interested in policing, just politicking

The economy: it's not as bad as the Sixties

We have dealt with inflation before - and if we learn the lessons of the past we can do so again