Sunday, January 24, 2010
Jobs joy takes the sting out of inflation misery
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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When one door opens, another slams in your face. Just as the news on unemployment is getting better, inflation takes a turn for the worse.

There is a long tradition in economics that says these two things are directly related but I do not think this is what is happening here. There is also the tradition of the "misery index" the sum of the unemployment and inflation rates and that rose sharply, by the full percentage point of the jump in inflation from 1.9% to 2.9% (unemployment was steady at 7.8%).

I will come back to inflation. Unemployment has now fallen for two successive months on the claimant count and recorded its first fall on the Labour Force Survey measure since May 2008. Having been widely predicted to reach 3m by now, it is 2.46m, and has so far failed to breach the 2.5m level. Vacancies are rising again.

This is good news, and not just for those who might have become unemployed, between 450,000 and 500,000 on government estimates. Following tentative evidence the public finances may not be quite as disastrous as feared, official calculations suggest lower-than-expected unemployment could cut public spending by a cumulative 17 billion over the next five years.

I have focused on labour-market flexibility, particularly wages and working hours, which has been very important. The Department for Work and Pensions also emphasises the role of labour-market policies in improving the outcome.

Jobcentres are doing well and the department extracted money from the Treasury for labour-market support during the crisis. Unlike in previous recessions, people have not been shifted off the claimant count into other benefits; there has been a net flow into jobseekers' allowance from lone-parent and incapacity benefits.

Inflows into unemployment have been lower than in the last recession and people are leaving the register faster; 70% leave unemployment within six months, compared with 63% in the 1990s and 60% in the 1980s. Employers, having once written off the official employment service, now express more than 90% satisfaction with it.

The government is also targeting help at the young. The latest figures showed a drop of 16,000 to 927,000 in the number of young people unemployed, and 29% of them are full-time students wanting part-time work. But this total is still too high and the job market is still a long way from normal.

As Nigel Meager, director of the Institute for Employment Studies, points out: "The number of working-age people out of the labour market has breached 8m for the first time. A growing number of these would like to work and many are underemployed, with more than 1m part-time workers unable to find full-time positions."

So despite the good news, the job-market misery has not gone away, though it has been less than feared. It will be a miracle if we get through January-March without some renewed rise in unemployment.

Mervyn King offered his own bit of misery last week. The Bank governor gives four big speeches a year. This one, as always, was elegant and well-argued. But King sounded like a dispassionate commentator on the economic scene, rather than somebody with his hands on the levers.

"The patience of UK households is likely to be sorely tried over the next couple of years," he said. "There is little scope for growth in real take-home pay, which may remain weak even as output recovers. It is clear that inflation is likely to pick up markedly in the first half of this year." Any sense the Bank had anything to do with this was hard to find.

Perhaps this was what provoked Danny Blanchflower, a former member of the Bank's monetary policy committee (MPC), to call last week for a fundamental shake-up of the MPC. His mildest reform would be to revert to a measure of inflation that included house prices, the old RPIX (the retail prices index excluding mortgage interest payments). His biggest reform would be disbanding the MPC entirely and replacing it with a new committee focused more on unemployment than inflation.

I like Blanchflower a lot but he is technically wrong to say that a shift back to the old RPIX target "would make it clearer that we are in a deflationary period". RPIX inflation was 3.8% last month, well above its old 2.5% target. King will have to write a letter next month explaining why consumer price inflation has risen above target. He would have had to write one this month on the basis of the old target.

As for having a different kind of MPC, not focused solely on inflation, that is a much bigger question. The MPC can and will have to take more account of what is happening in the financial system.

It will need new tools to try to prevent the collective behaviour of the banks from risking the entire system. That will affect its use of the interest-rate weapon. But this is no time to talk about an MPC focused on unemployment rather than inflation. With the fiscal rules no more, getting rid of the inflation target would be seen as an act of financial suicide by the markets. At a time when some are already ready to conclude that the Bank has taken too many risks with inflation, this would be the final nail in the coffin.

Why is the Bank, from the governor downwards, so useless at responding to fundamental criticisms like this? They appear to regard Blanchflower as a disgruntled former employee who will eventually go away. He will not, and neither should he. But the argument for an independent central bank and inflation target should be incontrovertible. Few questioned that low inflation delivered benefits in growth and employment, particularly in a country like Britain with a history of price instability.

The Bank needs to make that case again, and in a way that reaches ordinary people and businesses. Otherwise the MPC could see its rationale eroded away.

Which brings me neatly back to the latest inflation figures. With the money supply subdued Bank of England figures suggest M4 fell last month average earnings growth weak and oodles of spare capacity after the recession, there are only two genuine routes to higher inflation: the weak pound and higher commodity prices.

The pass-through from sterling is a one-off, and rises in commodity prices will be offset by weak domestic inflationary pressures. The Bank knew an inflation spike was coming, and must grin and bear it.

What it should not do, in my view, is announce any more quantitative easing next month beyond the existing 200 billion. Despite strong arguments for this being a temporary blip, to do so would risk looking like the Bank did not care about inflation. It should pause.

PS: Lord Richardson, who has died at the age of 94, ran the Bank of England in an era when a gentle raising of the governor's eyebrows was enough to make the City sit up and take notice. Mervyn King paid tribute to him as "a man of dignity who served the Bank and the country with distinction. He was held in great affection by all who knew him."

The job description of governor has changed over the years. Richardson started life as a barrister, then had a career in the City, before joining the Bank.

He was governor at the time of a crucial change of government. He had taken the job in 1973 and went through a turbulent period that included the International Monetary Fund bail-out of Britain in 1976. Then in 1979 Margaret Thatcher was elected prime minister.

Things became difficult. The Bank was sniffy about what it regarded as Thatcher's crude monetarist approach and Richardson, famously patrician, did not take kindly to being shouted down by a woman prime minister when the money supply ballooned in 1980.

Lord Burns, chief economic adviser to the government at the time, recalls that Richardson found that period difficult but that some of the accounts of the amount of blood on the carpet were exaggerated. Burns and Richardson remained friends after he stepped down as governor in 1983.

From The Sunday Times, January 24 2010