Right, here we go, part III. I have to admit I was feeling quite hungry during most of this session, so my notes have large gaps which my economics knowledge isn’t capable of filling. Nevertheless here’s what I picked up between kitkat cravings…
The theme is inflation. Tony Blair made the Bank of England independent and told it to control inflation at 2%. Their tool was control of interest rates. They were allowed 1% either side, any more variation than that and they had to write an apologetic letter. It has actually worked quite well, with inflation staying pretty close to 2% most of the time, although in December it jumped from 1.9% to 2.9%, and some predict it might go as high as 3.5%. Nonetheless, this is nothing compared to the 25% we saw at times in the 1970s (or Zimbabwe’s ridiculous recent performance).
Inflation is a sustained increase in overall price levels, accompanied by a fall in the value of money. Ie things cost more at the same time as every pound is worth less. If it’s anticipated it can be a very useful tool of economic policy, for some reasons that sadly I never caught. The only two I did write down were that: higher inflation reduces the value of national debt, which is good; and business quite likes it because it weakens the pound, which makes importing raw materials easier and reduces the competition from cheap imports. A downside is that it makes savings worth increasingly less – it has been described as a tax on savings (using tax in the sense of something onerous, rather than a contribution to society, a bugbear of mine that I might write about another time).
The problems come with unplanned inflation, that can race out of control and screw everything up (like the UK in the 1970s or Zimbabwe very recently.) It hugely increases the risk of investing, and also changes consumer behaviour dramatically – panic buying, increased demand initially, followed by a massive fall in consumption. Not good.
Then we moved on to the causes of inflation. You can either have a shock on the supply side (so something goes wrong with production – perhaps the raw materials get too expensive), or a demand shock (where something goes wrong with consumers, who stop buying somethings all of a sudden). And then either way, government reacts to shocks by increasing the supply of money, which leads to inflation. Now, apparently this makes sense if you look at Fisher’s Law, which I didn’t quite follow, but apparently says this:
Supply = Demand
M * V = P * T
Where M = amount of money that can be in circulation
V = velocity of money (whatever that means)
P = Price of each transaction
T = National income
Therefore when government raises M, and V and T stay the same, P has to rise, which is inflation. I understand that, but I don’t really understand why MV = PT. Any helpers?
Anyway, moving on. How to control inflation is the next tricky question. The main tool is interest rates, which can be manipulated to change the ratio between consumption and saving (higher interest rates leads to higher saving, presumably?)
However, government doesn’t want interest rates to go up very much at the moment, because that will make paying back the debts much harder. So what’s the alternative? That, sadly, is where I stopped paying attention, right up until the end. So, any ideas on that much appreciated.
It hasn’t been my strongest contribution this week I’m afraid, but I promise I’ll try and do better next time. I’m going to take my graph-based introduction to economics on holiday, and report back. Oh yes I am.