Gentle inflation is a spur to spend – because if you’ve got the money and you’re not feeling gloomy, then you will spend today, because tomorrow prices might be a bit higher.
It is also a spur to borrow for investment, in a home if you are a household or in productive kit if you are a business, because if you think your earnings will at least rise in line with inflation, then the burden of your debt will diminish with passing years.
So moderate inflation tends to be associated with steady growth in national income – of the sort that should make us sustainably richer
That is why the government has set a target for the Bank of England of setting monetary conditions – through changes to the interest rate for lending to banks and via quantitative easing – to keep inflation at 2%, with a one percentage point margin of error on either side of 2%.
So with CPI inflation today announced at 0.5% for December – the joint lowest since records began in 1989 – the Bank of England has failed.
And for the first time ever it has failed because inflation is too low (it missed the target on the upside well over 30 times after 2007).
Now as I said yesterday, that failure is – arguably – good news, at least in the short term.
That is because what has been driving inflation lower has been a 10.5% fall in motor fuels over the past year and a 1.9% fall in food prices. And since we have to buy food and fuel, those reductions increase our spending power, they make our money go further – they are the equivalent of a lovely hefty tax cut (of the kind that the chancellor would love to give us but can’t afford).
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