Imagine a world where prices go down, not up. Imagine a world where salaries don't rise

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It is easy to predict that higher interest rates are on the way but much harder to predict the profile of the climb. A few analysts in the City were surprised that the Bank of England did not move last week. They muttered about a split in the Bank's Monetary Policy Committee and missing the opportunity to pre-empt the markets.

It is easy to predict that higher interest rates are on the way but much harder to predict the profile of the climb. A few analysts in the City were surprised that the Bank of England did not move last week. They muttered about a split in the Bank's Monetary Policy Committee and missing the opportunity to pre-empt the markets.

Ignore that. It would be very odd if there were not a split because the evidence of the need for a rise is ambiguous. In any case, whenever people make a wrong prediction they tend to be cross. When they make one that costs their employer serious money they become seriously cross.

There are at least four sensible reasons for delaying the rise in interest rates for as long as possible.

One is that the pound has strengthened in recent weeks, which puts a squeeze on the economy. The Bank used to have a rule of thumb that a one percentage point rise in sterling is similar to a quarter-point rise in interest rates in the extent to which it cuts demand. That no longer works as well as it did when nominal interest rates were much higher, and, in any case, it squeezes a different part of the economy, the exporters, as opposed to the consumers. Nevertheless, there is little doubt that a higher pound does cut overall demand and it is certainly true that each rise in interest rates will tend to push the pound higher still. That would not be a great idea given the present current account deficit.

A second reson is that the lag between any change in rates and the effect on different parts of the economy is most uncertain. Take the impact on the booming housing market, the main current concern. It may be that the upward moves to date, coupled with the fear of further rises, will be enough to curb the market; most people feel they are not, but it is perfectly possible. If the "buy to rent" sector were to falter, the market could come back very fast, and that sector is probably more sensitive to interest rates than owner-occupiers.

And a third reason is that no one knows what will happen to rates elsewhere - in particular, whether the European Central Bank (ECB) will cut them to boost flagging demand on the Continent. Some people were surprised that it did not cut rates after its last meeting.

US rates will not rise by much before the November presidential election, maybe not at all. UK rates are already out of line when set alongside the eurozone and the US, as the graph shows. That is largely a function of the strong consumer demand in the UK: we need higher rates than the Continent to curb our much faster growth. Nevertheless, to push rates up just as the eurozone was pulling them down might not be a very good idea because it could encourage sudden capital flows as Europe's spare cash seeks a better-paying home.

Finally, there is very little inflationary pressure in the labour market or in most product markets. We are in a world where all developed countries are competing against people in China and India, who of course have much lower wages. This holds down costs everywhere. The formal remit of the Bank is to target current inflation, not the price of assets or the level of consumer debt. Obviously these might have an influence on future inflation, but the links are loose and uncertain. The Bank does have to follow its legal remit.

Put these together and there is a perfectly respectable case for caution. As a general principle in monetary policy, as indeed in other aspects of life, when in doubt do nowt.

This does lead to a more general point. Central banks worldwide are following expansionary policies. The US Federal Reserve is the most notable expansionist, but if you look at monetary growth, both the Bank of England and the ECB have also allowed rises in the money numbers well above inflation plus the real growth of the economy.

The relatively slow pull out of the trough by most countries cannot be put down to any refusal by the central banks to supply funds to the markets. In the US, the Fed has tried to pump up the economy with what in real terms is free money. In Japan they have had zero nominal rates for years, though they have positive real rates as a result of falling prices. In parts of Europe there are zero or negative real interest rates, and even in Germany, which has the highest real rates (because it has the lowest inflation), short-term rates are only around 1.5 per cent. And in the UK there have certainly been no monetary curbs on growth.

So why, if there is plenty of money around, are most developed countries making a pretty slow recovery? Even in the US, which according to the figures has seen decent growth, there has not until very recently been much growth in employment.

My best answer is that we are in the middle of a historical shift from a world of inflation to one of price stability. It is not a straight-line shift and it is taking place at different speeds in different countries. Japan has already reached price stability, while most other nations still have some way to go. There could well be a little upward kick in inflation this autumn and next year, and higher interest rates will be needed to curb that. But the markets are deeming that the inflation dragon has been slayed: that is why they are prepared to lend governments money for 25 years at not much above 4 per cent.

And the rest of us? Well, we cannot really believe that inflation will disappear. We cannot imagine a world where as many prices go down as go up. We cannot imagine a world where salaries hardly rise year by year. And in Britain at least, we cannot imagine a housing market where prices overall don't rise, don't fall, but just go sideways for a decade or more.

My guess is that as world economic growth picks up this year, US and eurozone rates will eventually rise a bit. If the UK economy continues to speed up, we too will get somewhat higher rates. We may get them quite soon. But we should be aware, too, that we are probably in the middle of a process we have never experienced before - the move to stable prices.

We should see any rise in interest rates, here or elsewhere in the world, in that context.

How budget airlines sank Eurotunnel

If you want to see the power of the market in action, look at what a change in relative prices is doing to tourism. Easter is traditionally the busiest weekend of the year for travel, and this year seems to be no exception. But as you push through the throng at the airport, ponder the way the budget airlines have transformed the travel industry.

Eurotunnel is in a mess partly, though not entirely, because rail travel to the Continent has fallen far short of rail companies' estimates. Air travel by contrast has soared. The reason? The budget airlines, Ryanair in particular, have changed the nature of the travel proposition.

Look at the deal first from the point of view of the travel companies. Before the budget airlines came along they looked at the various travel markets and saw how many people where going between, say, Paris and London. Then they estimated how the market might grow and what proportion of the market they might capture. That was how the train companies looked at the Channel Tunnel proposition and how airlines decided whether to try new routes. We, for our part, decided where we wanted to go, checked the prices and times of flights, trains, ferries or coaches and made a decision on what to do.

Now it is different. The budget airlines find a city on the Continent, with an airport nearby, that wants to bring in new business. They say to the local business leaders, suppose we open up a route, in the first instance to London, how will you help us? The local airport owner gets together with the municipality and puts together a deal, including cheap landing rights, local transport options and so on. New business suddenly comes to the city. We punters, for our part, start by looking at where the cheap flights go to, reckon that a weekend in, say, Prague, sounds fun, and find that the flights cost the tax and not much more. Drink and accommodation is so cheap that it won't be much more expensive than a weekend in the pubs and shops at home - so we book up.

And this is all the result of a change in the relative prices of airline travel and UK goods and services. One has become cheaper, the other more expensive. We are all prisoners of the laws of supply and demand, especially at Stansted airport.

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