Paul Krugman: British Inflation: A Teachable Moment
Krugman:
British Inflation: A Teachable Moment: Adam Posen gave a talk yesterday (pdf) about British monetary policy that drives home a point I’ve been meaning to make; namely, that what’s happening in Britain on the monetary front right now is very much a teachable moment for monetary policy more generally. The Bank of England faces the same kind conflict between what it should be doing and what it’s under pressure to do that faces the Fed, but in starker form. And if the BoE holds its ground, we should soon have a clear demonstration that one side is right and the other is wrong.
The story so far: Britain is currently experiencing relatively high headline inflation, more than 4 percent over the previous year. And so there are demands that the BoE tighten. Yet the bulk of the rise in inflation clearly represents temporary or one-time factors: a rise in value-added taxes as temporary breaks introduced during the recession expired, commodity prices, and the once-off effects of the fall in the value of the pound against the euro. Nonetheless, the inflation hawks demand a rate rise, arguing that despite the still very depressed state of the economy, inflation must be nipped in the bud or it will turn into stagflation, 70s-style.
What Posen points out is that the case for preemptive monetary tightening to head off stagflation is entirely based on the 70s experience; there have been no other similar episodes in history. before or since. And the situation in Britain today bears little resemblance to the situation preceding any modern takeoff in inflation. Here’s unit labor costs in the quarters preceding several modern British inflation episodes, and this time around....
All the same issues apply in the United States, although in less extreme form.... What we can hope for is that the BoE stays the course; and when inflation in the UK drops sharply, as it almost surely will, that will be an object lesson in the folly of always making policy as if it were 1979.
