What inflation figures can tell us about the economic recovery

The spectre of deflation is haunting the Eurozone. A sclerotic economy, stubbornly high unemployment, and a dearth of investment are conspiring to limit growth and push down average prices. Now it looks like the spill-over effects are splashing onto British shores.

On August 13, the Bank of England (BoE) issued its quarterly inflation report, halving its forecast for annualised wage growth to 1.25%- the lowest since records began. Price inflation is similarly limited, and is not expected to reach the 2% targeted by the BoE Monetary Policy Committee until the end of the year. 

Managing prices is a finely tuned balancing act for central banks. Too much effort to stoke inflation and prices can spiral- reducing the real value of wages and diminishing savings. Too little, and investments become less profitable, demand slackens and unemployment results, at least in the short term. John Maynard Keynes Keynes recognised the threat to an economy posed by both inflation and deflation, but singled out the latter as the greater of the two evils.

However, the headline figures offered by the BoE offer a picture of average inflation only. While providing a birds’ eye view of the movement of prices across the economy as a whole, the BoE estimate lacks nuance. Drilling into the fine detail, meanwhile, a more interesting story emerges, and one that sheds light on the sort of economic recovery we’re experiencing.

The BoE states that inflation is low because of low food and energy prices, two items that receive a hefty weighting in the basket of goods used to define the Consumer Price Index (CPI). These two items make up roughly a quarter of the average family’s weekly expenditure.

However, when it comes to goods and services consumed by wealthier Britons inflation is soaring. Richer families are likely to spend more money than average on education, property, and luxury goods like watches, fine art, and sports cars. Interestingly, in 2013 inflation for Britain’s super rich was estimated to be double the average, at 4.9% compared to 2.4%. Stonehenge Wealth Management Group attributed this rise to both increased demand from foreign consumers from the Middle and Far East and improving stock market conditions which gifted wealthy investors with a tasty windfall.

Even for the moderately wealthy inflation is higher than the average. The costs of education- private tuition, private school fees, and university costs- have soared by 10.2% in the last year, according to Deloitte, an accountancy firm and consultancy. Why is this? Partly because private schools are increasingly attracting the children of the global rich to fill their classrooms, increasing demand, and partly because of the government hike in university fees to £9,000 per year. Wealthier parents are more likely to send their children to private schools and/or stump up the bills for university, increasing their personal inflation far above the average.

So there is rapid inflation at the top and slow disinflation- bordering on deflation- at the bottom. This reflects a lopsided economy. One where demand is uneven across the social spectrum, and where the relative purchasing power of rich and poor has widened to extreme levels. As research by Oxfam shows, the richest 0.1% of the UK has seen their wealth grow almost four times faster than the top 90% of the population. The coalition has done nothing to address this yawning gap.

Labour too needs to tackle this issue head on, and do so without blindly resorting to crude tax-and-spend measures. Yes, the wealthy need to pay a greater share to reflect their increased ability to weather the burden of taxation- hence why the reinstatement of the 50p tax band is a sensible and progressive measure. But simply taking from the rich and giving to the poor in the form of reducing tax for the lowest earners and boosting welfare expenditure does not increase the amount of wealth in society, nor does it accelerate income growth among the top 90%.

Increasing demand for goods and services lower down the social spectrum, making it easier (and cheaper) for people in poorer areas to travel and work in richer ones, and nurturing regional economies to break the hegemony of London and the south-east over the UK economy meanwhile, will. Here’s hoping Labour has the energy and ambition the coalition so sorely lack. 

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