The return of inflation should haunt politicians

Inflation used to be one of the central issues in British politics. Before that it was the balance of payments, and before that it was imperial preference. But in the 1970s and 1980s it was inflation. The 1974-79 Labour government even had a cabinet minister for prices and consumer protection, first Shirley Williams and then Roy Hattersley.

How to prevent prices from rising so fast was a task that defeated that government, and that was solved only by Margaret Thatcher. She had a succession of theories about the money supply (known as monetarism) that didn’t work, but which told her to raise interest rates, which raised the exchange rate, putting millions of people out of work – and that did the trick.

Inflation made a comeback towards the end of her time, as what Nigel Lawson, the chancellor, called a “blip” threatened to get out of control. The RPI (Retail Prices Index) peaked at 10.9 per cent the month before she was forced out of office, although the new CPI (Consumer Price Index), which is what we use now, was a better measure of true inflation at 8.1 per cent, and it rose to 8.4 per cent the following summer. That is the peak we are likely to approach this year.

Inflation dropped sharply when the pound left the European exchange rate mechanism and interest rates fell in 1992, and it hasn’t been a story since, apart from a brief rise – genuinely a blip – to 5.2 per cent in 2008 just before the financial crash.

Which means we have forgotten the old debates about the causes and effects of inflation. The idea of a wage-price spiral surfaced after the pandemic, as the recovery from the lockdown-induced recession caused labour shortages, which pushed up pay, which pushed up prices, in turn leading to pressure for higher pay.

It turned out, though, that these effects were minor, and that the real inflationary problem was simpler: a worldwide shortage of oil and especially natural gas. If that is right, the global energy market is likely to adjust and inflation will subside. The Office for Budget Responsibility predicts a rise (to about 8.4 per cent) at the end of this year, returning to the 2 per cent target zone by the end of next year.

Let us hope so, but in the meantime expect a lot of nonsense to be spouted. Rishi Sunak, the chancellor, is said to be alarmed that inflation will push up the cost of paying for index-linked debt – that is, government debt with interest rates linked to RPI or CPI. But that is a cash problem rather than a real-money problem because by definition the real (inflation-adjusted) interest rate remains the same. Indeed, inflation is generally good for the public finances in that it reduces the real value of non-index-linked debt.

But inflation is bad for many people because it reduces the value of savings and because, when the rate rises as fast as it has recently, people on benefits and the state pension fail to keep up. Sunak’s worst decision in the spring statement was his failure to uprate benefits by the actual rate of inflation, rather than the rate (3 per cent) prevailing six months ago.

Yours,

John Rentoul

Chief political commentator