Low Inflation in the UK
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Since the Bank of England was given independence in 1997 UK inflation has
been close to the government’s target of 2% +/-1. This is a remarkable
improvement for the UK economy. Previously the UK economy suffered from
consistently high inflation. Eg in 1979 inflation reached 25%. In 1992 inflation
reached 11%. Reasons for low inflation are a matter of debate. The chancellor
Gordon Brown likes to take credit for giving the Bank of England independence in
1992. However although this partly explains low inflation, it is only a small %
of the reason.
Reasons for Low Inflation in the UK
1. Economic growth has been more stable and predictable. The MPC have avoided
a boom and Bust economic cycle. At the first sign of inflationary pressures
increasing they have increased interest rates to reduce inflation before it
occurs (policy is known as pre emptive monetary policy.) This has avoided a
repeat of the late 80s inflationary boom.
2. Inflation expectations are lower. Partly as a result of the MPC’s greater
credibility. People expect inflation to be low, therefore wage demands have been
correspondingly lower. This has made it easier to keep inflation low.
3. The process of globalisation has helped to reduce costs and increase
competitiveness in global markets. The UK has benefited from falling prices of
manufactured goods that have been made in countries like China and Korea.
4. Improvements in technology. The internet and micro chip computers have
helped to increase efficiency and lower costs.
5. Increase in the labour supply. Increased immigration has created a new
supply of cheap labour which has helped keep wage pressures low.
6. Appreciation of £. This has helped reduce inflation, because imports are
cheaper and quantity of exports lower
However inflation may increase in the future. The Governor of the Bank of
England recently said there is no reason why the past period of stability and
low real interest rates will continue. Several reasons may cause inflation to
rise in the future including:
Why Inflation May Rise
1. Economic growth in China and India is causing high demand for commodities
and therefore prices are rising. This will feed through into cost push
inflation.
2. The UK has a large current account deficit. To reduce this deficit it will
be necessary to have a devaluation in the value of £, at some point.
3. The supply of labour is unlikely to increase by too much in the future.
Therefore wage inflation may become a problem as the labour market nears full
employment.
4. UK House prices continue to rise. This creates additional consumer wealth
and therefore increases consumer spending.
The effect of this is that in the future interest rates may have to rise in
order to keep inflation low. This will have the effect of keeping mortgage
payments high.
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall,
Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US
economies:
http://www.economicshelp.org/econ.html
Follow us @Scopulus_News
Article Published/Sorted/Amended on Scopulus 2007-03-17 00:22:18 in Economic Articles
