THE BLOG

Inflation Is Still a Major Risk to Our Economy

30/01/2014 17:08 GMT | Updated 01/04/2014 10:59 BST

So the headline rate of inflation has finally hit its target, for the first time in over four years. But let us not get too carried away in jubilation. We know from the past four years just how stubborn it can be.

Inflation has hit us all in the pocket harder than any other tax, four times harder than even the 2.5% rise in VAT. While Bank of England officials may be congratulating themselves on reaching the official target rate of 2%, the cost of goods and services experienced by consumers appears to be much higher. Inflation is a major threat to our long term prosperity, yet it could return because the economy is still on short term life support measures.

The government cannot borrow any more without risking the country's credit rating and raising the cost of all borrowing. Nor can it cut the deficit (still worth nearly a year's total domestic output) by putting up taxes. Four in every ten pounds' worth of production in this country is already taken and spent by the government. Further tax rises could discourage entrepreneurs and companies from taking on more staff or investing in their businesses so much so that they would tip the economy back into recession.

In these circumstances it has fallen to the Bank of England to step in, by keeping interest rates low and running a programme of quantitative easing (what used to be called printing money) in the hope that it will stimulate borrowing. But there has been precious little. Instead, we have seen rises in asset prices and the stock market reaching new highs, while business loans are actually down year on year The artificial new money created by quantitative easing has been used to buy corporate bonds and strengthen the banks' balance sheets but precious little has yet fed through to the real economy. When it does, we can expect inflation to rise again.

The only real winner from a rise in inflation is the Treasury, as a fall in the value of money produces a fall in the value of its borrowings relative to the taxes it is getting in. But for savers and businesses, rising inflation would be disastrous.

Inflation takes away the power of business to plan for the future. How can a business person know what the cost of a unit of production will be if raw materials and suppliers' prices are rising in an unpredictable fashion? Inflation forces business people to take less risk - and what we need to get the economy growing is more entrepreneurs taking more risks with their own money.

Inflation also destroys the wealth of individuals. Older people, who have worked all their lives to build up a pension pot or a savings account, should not feel they have to put their money into risky schemes to earn a decent return. Even if the interest rate for holding cash is extremely low, they want to know that the value of their savings will not be eaten away by inflation.

We need to look at other incentives to get the supply side of the economy performing. One is to remove unnecessary regulations on businesses so that they can put more time and resource into productive work; another is to make sure that government spending is focussed on its capital programme; yet another is to reflect on whether people might not be better at allocating money to productive use if we were allowed to hang onto it for ourselves, rather than let the Government take so much from us in tax. It is our money after all, isn't it?