Stagflation - we're not stuck with it (yet)

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Over at the IPPR Tony Dolphin has written a comprehensive commentary on the IMF's analysis of the UK economy. It's worth a look.

I'm not, however, sure about Dolphin's assertion that the UK is experiencing a “mild form of stagflation” which he argues is evident in that “real GDP increased by just 0.2% in the second quarter of 2011 and has barely increased at all over the last three quarters, while inflation remains above 4%.”

He has a point. Stagflation is defined by slow growth and high inflation. He also notes that in the next few months growth may well continue at its current slow pace, and inflation is likely to jump up for a bit when energy prices strike.

So this sounds like stagflation.

But Dolphin also makes two other points later in his blog that are pertinent:

1. Price inflation unexpectedly lower: Consumer price inflation was 4.2% in June, down from 4.5% in May (and retail price inflation was 5.0% from 5.2%). There is some evidence of discounting of electronic goods in response to weak consumer demand. Increases in domestic fuel prices – already announced – mean inflation will increase in the next few months – probably peaking at more than 5% in the autumn.2. Wages fail to keep up with prices: Average earnings – both total pay and regular pay – are increasing at an annual rate well below the rate of price inflation. This is squeezing households' spending power – the worst such squeeze since the 1920s. Over the last year, regular pay is up 2.1% and total pay 2.3%.

The reason price inflation was lower than expected – early discounting from retailers – is particularly important. Retailers are unable to push through price rises because of weak consumer demand. This would suggest, then, that while demand stays weak, inflation is unlikely to soar. And demand may well stay weak because, as Dolphin's second point, makes clear, wage growth remains muted.

In fact, despite commodity price and energy price rises, most forecasts for inflation show it falling back to target in 2012. Low wage growth is undoubtedly painful for households, and not being able to put up prices is hurting retailers. But it is holding down inflation.

So, while we are in a temporary high-inflation/low-growth situation, I would hesitate to call it stagflation. Because ‘stagnant' implies you're stuck with something. And if wage growth is muted, it's likely that inflation will be too.


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