Producer output prices increased by 5.7% in June compared to 5.4% in the prior month. This is almost three times the CPI target rate and a further blow to gapologists everywhere. Economics is often beset by fashion and more beleagured by dogma. Inflation theory is no exception. In 1970 Milton Friedman would have us believe that inflation is always and everywhere a monetary phenomenon. The oil price rise of 1973 sort of downed the MF helicopter.
In the early 1980’s, Lawson and others had us believe that government borrowing led to an increase in M3 and M4 money supply directly impacting on the inflation rate, a rational justification for dramatic spending cuts. I could never get by head round that and struggled with a paper on the subject for weeks.
In the mid eighties, the Bank of England believed that interest rates had no direct impact on consumer spending, the “monetary mechanism impacted on the economy via the investment cycle.” The problem was the BOE models had not adjusted to the Thatcher generation of mortgage laden home owners. An increase in interest rates was as as subtle as a pickpocket lifting the wallets of the vulnerable home owners.
In the early 1990s the relationship between the output gap and inflation rate was flagged by Goldman Sachs. It isn’t that GS have the best economists, they are just better at marketing them. For several blissful years, the relationship held, then started to break down. Apologists tried to explain the failure by “loss of capacity in the downturn”, the debate for me has long been exhausted and futile. It really is time to move on. Service sector economies don’t really have limits to capacity.
So back to the produce prices data for June. The headline rate hit 5.7% driven by increases in petroleum prices (16.5%), food (8.9%) and chemicals. The headline rate for input prices hit 17% with staggering increases in oil (40%), metals, (18%) chemicals (13%) and food (13%).
Input and output prices are coincidental and highly correlated (.851) with some evidence of a one month lag to impact (.854). They are also highly volatile and vulnerable to oil price shocks as the spike in 2008 attests. The Bank of England believe the spike in commodity prices will pass and inflation will return to target in the due course of time.
The MPC are beginning to look like a bunch of economists huddled in a storm shelter in Kansas hoping the tornado will pass by. It really is time to face the storm. In 2008, oil prices were driven higher by speculative trading and large derivative positions. The subsequent fall, reflected the closing of short positions pushing oil underground to $40 a barrel. The trend is for higher and higher prices as the high growth nations and China in particular places great demands on finite resources. Gapology is dead and monetary policy needs to reflect that. The increase in output prices to almost 6% with a trend output gap of the same dimension should be adequate evidence.
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The views expressed are my own and in no way reflect pro.manchester policy. In no way should the comments be considered as investment advice or guidelines or reflect political bias. UK Economics news and analysis : no politics, no dogma, no polemics, just facts. JKA is a visiting professor at MMU Business School, an economist and specialist in Corporate Strategy, educated at LSE, London Business School with a PhD from Manchester Metropolitan University.
Looking back to the old price that our oil had before, you can really see how much it has changed. I think it is a matter of having many factors.
Posted by: performance bonds | September 25, 2011 at 03:00 AM
I know that GS has the best economists, who are better at marketing. For the happiness of many years, the relationship was maintained, and then began to decompose.
Posted by: מתנות מקוריות | October 23, 2011 at 04:32 PM