Is inflation naturally self perpetuating or self controlling
Discussion
If most things become more expensive and pay fails to keep up with the cost increase is it simplistic to think that people will buy less stuff so the demand will fall and therefore prices.
Or
People secure pay rises that match inflation so employers increase prices to match the new costs so people then seek pay rises to match inflation...
Which would be the natural condition without government (and thinking of the 1970s, union) intervention ?
Or
People secure pay rises that match inflation so employers increase prices to match the new costs so people then seek pay rises to match inflation...
Which would be the natural condition without government (and thinking of the 1970s, union) intervention ?
Simpo Two said:
Interesting question. There's also (3) Standard of living falls. After all it can't go up for ever.
Isn’t that 1) ?Anyway, given inflation is being driven by a supply squeeze and energy prices it could fall as quickly as it rose if both calm down.
If not, it should be self regulating.
What is certain is that interest rate rises are not sensible.
steve-V8s said:
If most things become more expensive and pay fails to keep up with the cost increase is it simplistic to think that people will buy less stuff so the demand will fall and therefore prices.
I don't know about simplistic, but at least two major things have happened in living memory that have allowed prices to rise and pay to not keep up, whilst still maintaining demand.One being the significant increase in the number of women in the workplace, thus increasing household income, without the need to increase individual pay. The other being an equally substantial increase in the amount of personal debt through credit cards, loans etc.
Equality for women may certainly have given them greater opportunities, but it's equally possible that increased household income led to greater consumer demand, increased prices, and a situation where many now have to work when previously they might have chosen not to.
loafer123 said:
Simpo Two said:
Interesting question. There's also (3) Standard of living falls. After all it can't go up for ever.
Isn’t that 1) ?Anyway, given inflation is being driven by a supply squeeze and energy prices it could fall as quickly as it rose if both calm down.
If not, it should be self regulating.
[B]
What is certain is that interest rate rises are not sensible.[/b]
At least 1 (but only 1) of MPC feels the same way.
https://12ft.io/proxy?q=https%3A%2F%2Fwww.thetimes...
loafer123 said:
What is certain is that interest rate rises are not sensible.
I'm curious. Why is that certain?Low interest rates increase consumer borrowing, which increases demand, and allows for prices to rise faster than wages. It's one reason why property prices have risen to such an extent that it's that much harder for first time buyers. Increased interest rates (within reason) mitigate against that, as well as providing an enhanced return on savings.
I'm not saying your wrong, just wondering what the benefits are that outweigh those in my example.
For all sorts of reasons inflation is a scourge that is not self correcting, quite the opposite.
Inflation rewards the profligate, and penalises thrift and savings.
Interest rates should be higher than inflation, (to give savers a reason to save).
The big winner from inflation is government. An inflationary spiral that gets out of control can lead to price doubling every 24 hours.
QJumper said:
loafer123 said:
What is certain is that interest rate rises are not sensible.
I'm curious. Why is that certain?Low interest rates increase consumer borrowing, which increases demand, and allows for prices to rise faster than wages. It's one reason why property prices have risen to such an extent that it's that much harder for first time buyers. Increased interest rates (within reason) mitigate against that, as well as providing an enhanced return on savings.
I'm not saying your wrong, just wondering what the benefits are that outweigh those in my example.
Interest rates take heat out the economy by increasing debt costs and reducing debt appetite and disposable income.
As it is, we have a huge drag on the economy from energy price rises, and consumer spending and confidence is already tempering consumer spending.
The other reason for higher rates is to strengthen the currency, thereby reducing import inflation, but as this inflation is affecting everyone, our main partner currencies are staying pretty stable, so there is little need to do it for that reason.
A simple but effective way of looking at it is that interest rates are the price/ reward for buying stuff now or later. If (real) interest rates are higher it makes sense to spend less now, saving money, in order to spend more later, and vice versa. So higher interest rates reduce spending now, by increasing savings
In the UK, with mortgage debt being significant, they also have a more direct impact by removing money that can be spent on other things by increasing mortgage repayments
In the UK, with mortgage debt being significant, they also have a more direct impact by removing money that can be spent on other things by increasing mortgage repayments
QJumper said:
I'm curious. Why is that certain?
Low interest rates increase consumer borrowing, which increases demand, and allows for prices to rise faster than wages. It's one reason why property prices have risen to such an extent that it's that much harder for first time buyers. Increased interest rates (within reason) mitigate against that, as well as providing an enhanced return on savings.
I'm not saying your wrong, just wondering what the benefits are that outweigh those in my example.
I think he's saying the rate rises will hit businesses the stock/housing market hard, ie carnage?Low interest rates increase consumer borrowing, which increases demand, and allows for prices to rise faster than wages. It's one reason why property prices have risen to such an extent that it's that much harder for first time buyers. Increased interest rates (within reason) mitigate against that, as well as providing an enhanced return on savings.
I'm not saying your wrong, just wondering what the benefits are that outweigh those in my example.
But read about Volcker in the 80's https://www.stlouisfed.org/publications/regional-e...
Either he was right to do what he did or wrong/excessive?
We can't/won't do the same now? debt (to GDP) too high to service high rates? so perhaps we are going to find out in fact if inflation fixes itself and Volckers measures were unnecessary back then (or wouldn't have caused the disaster they thought?).
If they don't suppress inflation in some way or supply chain recovery doesn't stop it, then we all get poorer and disposable incomes drops, recession hits and possibly harder than ever due to the more fragile balance sheets of companies post covid and after 10 odd years of near zero rates on borrowing. If the governments print/support/loan more then potentially it's just can kicking at that point in indebts us all more and will possibly sustain high inflation.
loafer123 said:
A perfectly reasonable question!
Interest rates take heat out the economy by increasing debt costs and reducing debt appetite and disposable income.
As it is, we have a huge drag on the economy from energy price rises, and consumer spending and confidence is already tempering consumer spending.
The other reason for higher rates is to strengthen the currency, thereby reducing import inflation, but as this inflation is affecting everyone, our main partner currencies are staying pretty stable, so there is little need to do it for that reason.
Thanks for that, and I appreciate that we have an issue with energy prices at the moment.Interest rates take heat out the economy by increasing debt costs and reducing debt appetite and disposable income.
As it is, we have a huge drag on the economy from energy price rises, and consumer spending and confidence is already tempering consumer spending.
The other reason for higher rates is to strengthen the currency, thereby reducing import inflation, but as this inflation is affecting everyone, our main partner currencies are staying pretty stable, so there is little need to do it for that reason.
Outside of that though, isn't it just swings and roundabouts?
Why shouldn't consumer spending be tempered if it's financed by increasing consumer debt? Wouldn't reduced spending lead to less demand, thus lower prices and hence reduced inflation?
I guess what I'm saying is that consumer spending can be increased by either lower interest rates, or lower pricing, so why is it preferable to increase consumer borrowing over increasing the buying power of what people have?
QJumper said:
Thanks for that, and I appreciate that we have an issue with energy prices at the moment.
Outside of that though, isn't it just swings and roundabouts?
Why shouldn't consumer spending be tempered if it's financed by increasing consumer debt? Wouldn't reduced spending lead to less demand, thus lower prices and hence reduced inflation?
I guess what I'm saying is that consumer spending can be increased by either lower interest rates, or lower pricing, so why is it preferable to increase consumer borrowing over increasing the buying power of what people have?
There are other mechanisms which can be used to reduce borrowing, for example regulators can increase the amount of capital banks have to hold against consumer risk, or lending requirements can be tightened.Outside of that though, isn't it just swings and roundabouts?
Why shouldn't consumer spending be tempered if it's financed by increasing consumer debt? Wouldn't reduced spending lead to less demand, thus lower prices and hence reduced inflation?
I guess what I'm saying is that consumer spending can be increased by either lower interest rates, or lower pricing, so why is it preferable to increase consumer borrowing over increasing the buying power of what people have?
The issue with interest rates is that it is a blunt instrument, and whilst it might reduce consumer interest in borrowing, that appetite is already being substantially reduced by consumer nervousness in the face of war and rising prices, so interest rates may be the thing that slows the economy to a stall.
Posters here will obviously be interested in finance, so will probably know this anyway, but it might be worth a mention.
Inflation can be an advantage for those with debt. Many of the present older generation, benefited by buying their homes using mortgage debt in the 1970s. Property prices and wages moved upwards, but the amount of their mortgage debt remained the same. The percentage of equity in their homes increased more rapidly than normal, because inflation was unusually high. Think the RPI peaked at 25%.
The initial high value Pounds debt, was being repaid with lower value depreciated Pounds. Interest rates obviously increased with inflation, so keeping a job was crucial.
Governments can benefit even more, when there is a period of high inflation. Government borrowing (issuing debt notes called Gilts) is often done on a very long timescale and importantly at fixed interest rates.
One extreme example was a Gilt named 'War Loan 3½% Undated', which was issued during the first world war. (Initially it was 5%).
If someone put £200 into that, they would have received £7 interest every year (taxable). In 2015, interest rates were so low, that it suited the government to repay that Gilt, because they could by then borrow at lower interest rates than 3½%. They bought back that Gilt from the current holders.
The real killer for the holders of that Gilt was inflation, because £200 lent to the government in 1920 by buying the Gilt, might have been enough to buy a small house then. By 2015 though, when the government repayed, £200 could only buy a fortnights grocery!
So the message is, debt works well during inflation for buying homes, but only if employment remains secure to keep up repayments.
Conversely, cash savings (Gilts are a cash equivalent) are guaranteed to lose money over a long-term, especially during periods of high inflation.
.
I typically keep about 3 months net salary, which is about 5-6 months living expenses, in a 'savings' bank account as an emergency fund. Everything else is in a S&S ISA, SIPP, or other pension funds.
I keep wondering if this is now too much. Has anyone else decreased the cash they hold based on increased inflation?
I keep wondering if this is now too much. Has anyone else decreased the cash they hold based on increased inflation?
steve-V8s said:
If most things become more expensive and pay fails to keep up with the cost increase is it simplistic to think that people will buy less stuff so the demand will fall and therefore prices.
Or
People secure pay rises that match inflation so employers increase prices to match the new costs so people then seek pay rises to match inflation...
Which would be the natural condition without government (and thinking of the 1970s, union) intervention ?
Inflation, and pay failing to keep up with prices are two different things. Inflation in itself just means money is worth less, so unless something else is going on (which it normally is) wages and prices will rise by the same amount. This makes inflation self perpetuating or even self accelerating as people try to get pay rises in line with anticipated inflation.Or
People secure pay rises that match inflation so employers increase prices to match the new costs so people then seek pay rises to match inflation...
Which would be the natural condition without government (and thinking of the 1970s, union) intervention ?
Whatever else is going on might work either way of course. An increase in prices due to shortages as opposed to due to inflation will cause wages to fall behind prices. Labour shortages will do the opposite. So both will lead to true inflation but generally wage inflation is faster than price inflation.
QJumper said:
loafer123 said:
Interest rates take heat out the economy by increasing debt costs and reducing debt appetite and disposable income.
As it is, we have a huge drag on the economy from energy price rises, and consumer spending and confidence is already tempering consumer spending.
The other reason for higher rates is to strengthen the currency, thereby reducing import inflation, but as this inflation is affecting everyone, our main partner currencies are staying pretty stable, so there is little need to do it for that reason.
Thanks for that, and I appreciate that we have an issue with energy prices at the moment.As it is, we have a huge drag on the economy from energy price rises, and consumer spending and confidence is already tempering consumer spending.
The other reason for higher rates is to strengthen the currency, thereby reducing import inflation, but as this inflation is affecting everyone, our main partner currencies are staying pretty stable, so there is little need to do it for that reason.
Outside of that though, isn't it just swings and roundabouts?
Not really.
Energy cost inflation is probably one of the most difficult to reverse.
So many business sectors are subsequently and rapidly impacted by their own increased energy costs, that price rises quickly occur in so many goods and services.
Harry Metcalfe (YouTube Harry's Farm) was speaking recently about a five times increase in the price of nitrogen fertiliser. Wheat crops can double the growth of wheat seed quantity by using nitrogen. That dramatic price increase means normal use this year will be unaffordable. Therefore the knock on this year will be a smaller crop, less and more expensive flour and so inflation in bakery.
Edited by Jon39 on Thursday 7th April 14:27
alock said:
I typically keep about 3 months net salary, which is about 5-6 months living expenses, in a 'savings' bank account as an emergency fund. Everything else is in a S&S ISA, SIPP, or other pension funds.
I keep wondering if this is now too much. Has anyone else decreased the cash they hold based on increased inflation?
It depends how those investments perform - most are struggling to keep up with cash so far this year (they went down & somewhat recovered)I keep wondering if this is now too much. Has anyone else decreased the cash they hold based on increased inflation?
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