Is high inflation in the UK dead or dormant? Kit McMahon, formerly chairman of Midland Bank, takes an historical look at rising prices and considers whether inflationary fears are now dampening growthby Kit Mcmahon / February 20, 1996 / Leave a comment
In April 1992, when the annual rate of inflation in the UK dipped below 4 per cent, it was only the second time it had done so in 24 years. During those years the pound had lost seven-eighths of its purchasing power. At its height, during the 1970s, annual inflation had been in double figures for six out of seven consecutive years. Moreover, the only previous year that inflation fell below 4 per cent (in 1986) appeared to have been a fluke: price rises soon started accelerating again, briefly reaching 10 per cent during 1990 before dropping back.
It is not therefore surprising that for everyone under, say, 45-which includes almost everyone working in financial markets and most financial and economic commentators-there has been much scepticism about sustaining low inflation. In particular there was widespread anxiety that being driven out of the Exchange Rate Mechanism (ERM) in September 1992 would swiftly lead to a resurgence of inflation. But despite a substantial devaluation of the pound, inflation in the succeeding three years averaged below 3 per cent. Will this prove too good to be true?
Three questions arise. How inflation-prone does history suggest the UK to have been? How far are the factors which have caused most inflationary trouble in the past likely to persist? And how does past experience of inflation, through expectations thereby generated, influence its future course?
The long view
Among the main industrial nations the UK is often thought of as a relatively high-inflation economy. But on the long view that is not so. If we imagine ourselves back 50 years, what would then have been our memories of inflation? Naturally prices had risen during the second world war (by about 30 per cent) but even so they were no higher in 1945 than they had been in 1918. Prices doubled during the first world war but, going back further, the price level in 1914 appears to have been considerably below that of 1815.
Comparisons over such long periods are impossible to make with any precision. Not only are the statistical sources relatively poor; it is also difficult to link price indices when what people buy and consume has changed so much. Who cares what candles cost today? Who knew what oil cost then?
But there are other ways of assessing what one might call the “inflationary climate.” Most statistical problems inherent in the construction of…