Bit part for inflation

The trends in wages and prices in Britain are becoming more interesting than the trend in the economy, for they suggest that inflation may be a much smaller problem this cycle than it seemed even a couple of months ago.

True, the path for the economy is completely clear. But most forecasters are increasing their estimates by the month in response to figures such as the jump in industrial production reported this week. Indeed, it looks as though growth this year will have a two in front of it instead of a one - when the figures are revised a few times, as they always are, GDP for calendar 1993 will be up 2.1 or 2.2 per cent and not the 1.7 or 1.8 per cent that is the consensus forecast. There is every prospect of a higher figure, high twos or low threes, for 1994.

There is a much wider spread of opinion, though, on prospects for wages and prices. This year there is no serious problem for inflation, but there be might next. At one end of the scale come organisations such as Nomura, which is forecasting both headline and underlying RPI of more than 5 per cent by the end of next year. At the other end comes Tim Congdon's Lombard Street Research, which is forecasting both forms of RPI at 1 per cent for the last quarter of next year.

This is a wide spread even by the standards of the economic forecasting trade. Behind it lies a different perception of how economies work. The high-inflation school is particularly concerned with the lagged effects of devaluation, the fact that as demand rises manufacturers will want to rebuild margins, and the desire of employees to rebuild wages.

The low-inflation school focuses instead on low monetary growth and thinks that what companies might want to do with their prices, and workers want in wage settlements is irrelevant: they will not be allowed to put up prices or wages because of competitive pressures. One could simplify the two positions into saying that the high-inflation people expect the economy to behave as it did in the past, while the low-inflation ones think something fundamental has changed.

So which is right? Any judgement is going to be intuitive, but such evidence as there is does seem to be piling up on the low-inflation side. There was the fall in prices last month, announced on Wednesday, resulting in headline RPI dropping to 1.2 per cent year-on-year. But more interesting than the fall was the principal reason for it: summer sales. There are two different ways of seeing this. One is to say that it is simply a result of market conditions and that retailers will soon stop. The other is to say that the future is here: retailers will have to learn to offer value or they will fail.

Another example, a transatlantic one, is the new policy by Procter & Gamble of cutting prices of household goods and finding savings to pay for them. And another is the price cut by the Sun newspaper - if it holds the price down after the summer, then the cut will be really significant.

But price-cutting cannot be sustained unless the rate of wage increases comes down, which is why yesterday's earnings figures are extremely helpful. It really does seem as though a sea-change has taken place in people's expectations about the going rate. This is very different from the middle 1980s, when unemployment was at roughly the same levels as now but when growth in annual earnings stuck at more than 7 per cent, double the present rate. The great puzzle of the 1980s was the failure of settlements to fall despite the weakness in the labour market. It may have been because unemployment was less evenly distributed through the economy then but, whatever the explanation, what is happening now is very welcome.

If Professor Congdon is right on inflation, other things will come right too. The balance of payments is a good example: he has the current account deficit at an acceptable pounds 10.5bn for 1994; Nomura has it at an unacceptable pounds 30.1bn. But most important of all, inflation at 1 per cent really will make the country feel different.

Housing will again be seen principally as a consumption item, not an investment one. Pay discussions will become less confrontational, because people will not feel they have to fight to stay in the same place. More interesting still, people will start to expect to receive rises in living standards through a fall in prices rather than a rise in income.

For example, in a 1 per cent inflation world a lot of individual items will become cheaper each year: the experience of PCs, VCRs and cameras, all of which have seen falls in prices, will become more widespread. If there is in effect no inflation, local authorities will not be able to use 'inflation' or 'rising costs' as a general excuse when they put up the council tax.

People in Britain have very little experience of this. Few remember what it was like in the 1920s, the last period when the general price level fell. But those who can will recall a quite different set of attitudes towards borrowing and saving, indeed towards money in general.

Of course the low-inflation school may be wrong. If low inflation is to be sustained, it will need to become a worldwide phenomenon, not just a British one. One country can do a bit better than its neighbours but the world basically moves together. So far, though, there is little sign of a resurgence of inflation in the US, the first G7 country to come out of recession, and none in Britain, the second country to come out. The argument is going Professor Congdon's way.