To control inflation, we need to stop obsessing about it

It is hard to claim that inflation policy under any government has been a great success

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We get the latest Inflation Report from the Bank of England on Wednesday, an important one as it will give the background information – the justification, you might say – for the decision last week not to increase interest rates. It seems certain that at least two members of the monetary policy committee voted in favour, and we will get details of the debate in the Monetary Policy Committee minutes published next week.

The nub of that debate is whether you should pay more attention to the rate of growth in the economy, falling unemployment and still-rising house prices, in which case you would increase interest rates. Or whether you stress global uncertainties, the stalled European economy and below-target current inflation, in which case you would keep them where they are. You can make a decent case either way.

But pause a moment. Why this focus on inflation? The explanation lies in the surge of inflation in the early 1990s, with the retail price index topping 10 per cent in 1990. We tried to introduce some discipline by joining the European Exchange Rate Mechanism, but that did not turn out too well.

When the UK was ejected from the ERM on 16 September 1992, the Treasury cast around for some other anchor for policy. The chosen one was inflation targeting, and the initial target for the RPI, excluding mortgage interest payments, was set between 1 and 4 per cent. The purpose of the Inflation Report, first published by the Bank in February 1993, was “to provide a regular report on the progress being made towards the Government’s inflation objective”.

Independence for the Bank to set interest rates was still four years away, with the election of the Labour government, but it is hard to claim that policy under any government has been a great success. Not only has the Bank repeatedly overshot the top end of the revised target range for current inflation. Its performance on asset inflation – not targeted but of course associated with the house price bubble and financial instability – has been even worse. Take just two items. Petrol in 1993 was 45p a litre and now it is 130p, a three-fold rise. But the average house price in Britain then was £50,000, whereas now it is £272,000, more than a five-fold one.

The charge against our present monetary arrangements is that we have an organisational structure that overemphasises current inflation, even if it is not particularly successful at curbing it, and underemphasises asset inflation, which is socially just as corrosive, arguably more so. Having to shell out a lot for filling the car is one thing; having a society where young people can’t afford to buy their first home is another.


But there is a huge problem. How do you measure asset inflation and can you sensibly target it? It is hard enough to measure current inflation. We have the consumer price index, but that is a harmonised European index and does not fully allow for housing costs. There is the retail price index, tried and trusted since 1956 – with an earlier version going back a century. But it is considered technically crude and probably does overstate inflation.

The Office for National Statistics is manfully trying to improve both indices. Thus there is a new CPIH, which seeks to include the costs of owner-occupied houses, and there have been efforts to change the formula for the RPI. But no tweaking of these indices can cope with a world where a lot of new services come free. Thanks to downloads and apps, we must be rather better off than the stats show, but how to measure that benefit is tough indeed.

As for asset inflation, well yes, you can measure it but judging what to do about it is more of an art than a science. We know a lot about house prices and commercial property; we also know a lot about quoted share prices and about commodity prices; and we can make some guesses about other assets, such as unquoted companies and works of art. So I suppose you could construct a composite index of UK asset prices, ascribing weights to property, equities, bonds, and the rest. You could do the same for other countries, indeed for the world. But the idea of targeting asset prices – saying we think they are too high or too low and changing policy to “correct” them – would be an utter nightmare.

Still, central bankers ought to take them more into account. Nearly ten years ago, I was talking with Paul Volcker, who as chairman of the Federal Reserve between 1979 and 1987 was the key central banker who brought inflation back under control. I asked about inflation targeting. He stretched out his legs (he is 6ft 7in) and said that it was quite the wrong approach to put all this stress on inflation. What mattered above all was stability. We can now see how right he proved to be.

Does it matter if rich people spend less on top-end goods?

There is a chill wind blowing through the world of luxury. For the past five years, top-end consumers have been on a ride and the companies that court them have duly prospered. The Global Luxury Goods Market report just out believes that the market, worth $300bn last year, will reach $375bn in 2020.

The Independent's wine expert, Anthony Rose, wrote that while fine wines had fallen in price over the past three years, they were now making a comeback. Classic car prices are booming after a few tough years. Jaguar Land Rover opened its first plant in China last month.

Yet while there are gleams of light, a general unease seems to be afflicting the firms specialising at the top end. There are several specific reasons for this. Russian money is not quite what it was, for while most wealthy Russians will have exported capital, the plunge of the rouble has cut the value of their domestic assets and increased the cost of imports.

The Chinese authorities have cracked down on excessive displays of luxury as well as corruption, and the demonstrations in Hong Kong have disrupted top-end purchases.

In Brazil, a perceived anti-business climate and the fall of the currency have trimmed consumer imports. And in Europe the dip into recession in Italy and slowdown elsewhere has trimmed what was already a sombre market.

Should we care? No and yes. If the world’s wealthy use their funds to invest rather than display, then we should surely welcome that. And the retreat from luxury might be some small sign that inequalities could be set to narrow. 

But Britain and Europe specialise in the top end so what happens there does to some extent at least trickle down to the rest of us.