Karen Ward: Three reasons why the MPC members can sit back and enjoy their pina coladas

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The Independent Online

As the Bank of Englandinterest-rate setters prepare to embark on their summer hols, I wonder what books they'll be packing. With inflation ratcheting ever higher, some might be looking for complete escapism. A romantic novel perhaps? Others may reach for the history books – if only to reassure themselves that by the standards of the UK's troubled economic past, things really aren't so bad.

But those seeking deeper insights could do worse than heading straight for their local bookstore's popular science section. Buried among its shelves, they'll find a book that could hold a lesson or two for their current inflation predicament: MalcolmGladwell's The Tipping Point.

Published at the turn of the decade, as the dot.com boom was turning to bust, Gladwell's first bestsellerproposed three conditions required to reach a tipping point.

The first requirement he named the Law of the Few. The idea is that "the success of any kind of socialepidemic is heavily dependent on the involvement of people with a particular and rare set of social skills". This small cadre of influencers can play a key role in spreading ideas.

One example cited by Gladwell was the Hush Puppies brand. Struggling in late 1994, it took just a few New York fashionistas to bring it back from the brink. Others followed suit, and before long everyone was wearing them. Sales of Hush Puppiesexploded without a penny being spent on advertising.

Now, it's fairly hard to imagine those wise souls on the Bank of England's Monetary Policy Committee taking a turn on the catwalk when London Fashion Week kicks off next month. In the economic world, though, they are the trendsetters.As skilled practitioners, unsullied by political influence, these are people the public should be able to trust.

In the current economic climate, that credibility is crucial. Inflation may be high and set to rise further in the next few months. But in last week's Inflation Report, the Committee made clear that it views this as a temporary phenomenon. Inflation will be back to target before long, and that is the trend for price-setters and wage-bargainers to follow.

The second condition for a tipping point is what Gladwell calls the Rule of Stickiness. This is the idea that to achieve the desired change, a message has to be sufficiently compelling or memorable. Only then does amessage have much chance of beingassimilated and influencing behaviour.

The example cited in the book is the kids' TV programme Sesame Street. As its creators developed the concept, they found that the combination of people and puppets provided a memorable mix of reality and fantasy that helped kids to remember and understand what they had seen. It made their educational messages "sticky".

The MPC hasn't resorted to such gimmicks (although it would be great fun if it did) in its attempts to provide a compelling message. Its story is one of painful adjustment: too high global energy and food prices, credit market turmoil and over-valued property markets. Although a temporary bout of inflation is inevitable, inflation will return to target.

For a number of reasons, this is a more compelling message than those conveyed by other major central banks. The Federal Reserve, for example, may try to communicate that it will ensure the rise in US inflation is temporary. But it's saddled with a dual mandate, to ensure full employment as well as price stability. And it has acted far more quickly andaggressively than other central banks in cutting interest rates. Against this backdrop, is the Fed message really that "sticky"?

The European Central Bank, by contrast, has worked hard to deliver a compelling message about its inflation-beating credentials. It has even gone so far as to raise interest rates, at a time when growth in the region is grinding to a halt. But, despite its best efforts, the ECB is hamstrung by the inflexibility of the eurozone labour market.

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This inflexibility is most apparent in the prevalence of wage indexation. In a throwback to the UK economy of the 1970s, many eurozone countries still index wage increases to inflation. For thosecountries, higher inflation will feed into wage inflation, as surely as night follows day. And that raises doubts about the ability of the ECB to ensure that any burst of inflation does prove shortlived.

Unlike the Fed and the ECB, the MPC is able to boast of both a clear mandate to return inflation to target and the labour flexibility to ensure this happens. So it's rather easier for the MPC to make a compelling case that the temporary burst in inflation we're seeing is just that – temporary.

The third and final condition for a tipping point is the Power of Context. This states that human behaviour is highly sensitive to its environment. Gladwell argues that sometimes even the smallest of changes to theenvironment can produce a major change overall.

One example is the well-known "broken window" approach totackling crime. Cleaning up theenvironment by removing graffiti, picking up litter and mending broken windows can have a major impact on the crime rate. It can make more difference than a policy of more police and more arrests.

Economic outcomes are no less sensitive to environment. When the economy is booming, workers are more likely to push for pay rises. And firms, believing that they may well be able to pass increased costs on to consumers, are more likely to accede.

In the current economic climate, the opposite is true. Squeezed by higher food and energy bills, consumers are hardly at their most extravagant right now. And, with unemployment rising, workers are feeling far less secure in their own jobs. This isn't particularly fertile ground for any retailers bent on raising prices or workers anxious for higher pay.

As our bookworms on the MPCfinish their holiday read, they may therefore feel some comfort.Although inflation is set to risefurther over the next month or two, it will be falling sharply before too long, and the Committee will finally be able to provide the interest rate cuts the economy so badly needs. The tipping point is in reach. Time for another pina colada, I think.

Karen Ward is UK economist at HSBC.

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