2000s >> 2007 >> no-1238-october-2007

Cooking the Books 1: Why they like a bit of inflation

“We have succeeded in tackling inflation”, declared Gordon Brown (Times, 31 August). Why, then, are prices still rising?

These days “inflation” has come to be another word for “rising prices” whereas, originally and logically, the two were not the same: a rise in the general price level was the effect of an inflation (over-issue) of the currency, not inflation as such.

In any event, the original question – why, if inflation has been tackled, are prices still rising? – remains valid. The answer is that when Brown speaks of inflation being “tackled” he doesn’t mean that it has been ended, but merely that it has been brought under control. Governments everywhere pursue a policy of controlled inflation, over-issuing the currency by an amount calculated to lead only to a given modest rise in prices. In Britain the target the Bank of England has been set is to keep the rise in the general price level to 2 percent a year.

But why this policy? Writing in the Financial Times Magazine (25/26 September) Tom Harford suggested:

“One reason is that relative prices need to change frequently to reflect changes in the economy: this year, British peas will be expensive because the crop was ruined by floods. But clothes have been getting cheaper for years, thanks to low-cost manufacturers in China. And yet the evidence suggests that it is usually easier to raise nominal prices than to lower them. So a little bit of inflation which ensures the typical price change is up rather than down, means that these relative prices adjustments can happen more quickly and easily”.

This doesn’t sound all that plausible as why is it easier to raise rather than lower the price of an individual product? It is true that, with no inflation and so a stable price level, price reductions would be more frequent as the price of most manufactured goods would tend to fall due to increasing productivity.

It is not only the price of clothes that has fallen in recent years. So has that of electronic goods, but the manufacturers have had no difficulty in doing this; in fact being able to reduce their prices gives them an edge over their competitors. And a stable price level would eliminate many accounting problems.

But this is to forget the working class and the effect on what they have to sell – their working skills – and its price (wages and salaries). With a stable price level and increasing productivity, the cost of living – the main element in wages and salaries – would tend to fall. So, therefore, would money wages.

Keynes, the discredited 1930s economist, argued that

“a movement by employers to revise money-wages downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices” (General Theory, chapter 19).

Since it is the labour of wage and salary workers that is the source of capitalist profit, there is a permanent tendency for employers to seek to restrain wages. If workers can be tricked into not resisting these downward pressures as much if they take the form of other prices rising faster than wages, that means more for profits. An added bonus is that, despite a rising price level being a deliberate government policy, workers can be blamed for it for being greedy and asking for too big wage increases.

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