Almost all central bankers agreed last week that inflation was too high. What surprised everyone was how united and emphatic the position was.
No doubt individual decisions will differ, and there are many good reasons why people go with what they like. But it is hard to see how any central banker could come out in favour of inflation that high. Surely the main job of a central banker is to produce the very best results for the country?
What makes the opposing positions so striking is that they are very different. On the one hand, Bank of England governor Mervyn King wants to be tough on inflation but he is also very keen to avoid driving down economic growth through increased interest rates or other restrictive measures.
On the other hand, European Central Bank president Jean-Claude Trichet will tolerate inflation rising above his target of just under 2%. He thinks that this will push inflation expectations down, thereby preventing them from reaching the sort of “danger zone” seen in the US, where prices rose by 6.7% over the past year. There is only one problem. In the US, the danger zone is caused by what economists call “transitory factors”; in fact, they really aren’t. The latest inflation figures showed a 3.4% annual rise in petrol and 7.4% for food.
It is true that food and energy prices normally fall in the US when the recession is over. But food and energy prices tend to stay high for a few years after the recession has ended because new large-scale infrastructure projects are still being built. Moreover, a recent study by economists at the University of Warwick and the Bank of England found that higher fuel and food prices represented only around half of the annual rise in the cost of living between 1881 and 2005. Most of the rest came from changes in the way in which incomes were measured.
These concerns were based on empirical evidence and support what many of the most orthodox economists say is a truism: that inflation isn’t caused by the level of interest rates but by the nature of the economy. Once inflation starts rising, it cannot be arrested quickly by any change in the cost of borrowing. There are quite a few arguments as to how the recovery could happen in other circumstances. But this is not one of them.