Why is inflation so high?

When the credit crunch and economic recession hit the UK, like many people, I expected inflation to fall sharply and possibly go negative. Although it did fall somewhat it has now been high and rising for some time. It is currently 4.4% and has been above the official target of 2% for about 2 years. It is continuing to rise and remains much higher than in both the US and EU. Why is this? And what does it mean for the economic outlook?

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What a sustainable recovery would look like

The world economy is once again looking fragile. The UK economy contracted at the end of last year and unemployment remains stubbornly high across most of the West. Meanwhile there are signs that Asia is over-heating. While it’s easy to focus on the short-term outlook in many ways it is not the most important issue. More important are the questions: what happened to bring us to this point? and what does this mean a sustainable recovery will look like? To get a handle on these questions we have to go back a bit in time.

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2011 outlook

It’s nearly three weeks into January so it’s time to lay out a few predictions for what 2011 holds in store. I did this for 2010 and I didn’t do particularly well. It would be tempting to just say ‘it’s all too complicated’ and sit on the fence. But I like to do it because it forces me to think hard about issues it would be easier to avoid. Also, reviewing what you get right, and more importantly wrong, is a very good learning process. What I learnt from last year’s mixed record was that I tend to be too pessimistic and also that there is a lot of momentum out there – so the most likely thing is that current trends continue.

So here goes.

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Review of 2010 – UPDATED!

I have just updated this in the light of recent news that the UK economy contracted at the end of 2010 – it makes my record look a bit better!

A year ago I made some predictions about what would happen during 2010 and it’s now time to see how I did, and more importantly to see what I can learn from the experience. Overall it’s a rather patchy record but not one I think I need be ashamed of! Here is the break-down.

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Quantitative easing is now pointless

A couple of years ago an ugly term, hitherto condemned to abstruse economics textbooks, was suddenly all over the media – quantitative easing. This term describes the creation by Central Banks of new money which is then pumped into the economy. The idea is that the Bank uses this money to buy assets such as government bonds, thereby driving down their yield (the effective cost of government borrowing). If the cost of government borrowing falls, then so too should the cost of loans for consumers and businesses. This then should encourage consumption and investment, helping the economy to recover. Or at least that is the theory.

Quantitative Easing – or QE – was first tried in Japan during their decade long slump with apparently few positive effects. But when the West was hit by the mammoth credit crunch in 2007/8 it became extremely difficult for people to borrow money despite low base rates. So Central Banks turned to QE as a potential solution. It may well be that, along with the massive bailouts of banks, it did help to alleviate the credit crunch and thereby help prevent worldwide economic catastrophe (although it is still too early to tell for sure).

Now the US has just restarted QE and Central Banks stand ready to restart it in the UK and Europe should the recovery falter. But its highly likely that a further bout of QE now would be at best pointless, and at worst, actually harmful.

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Austerity is a massive gamble

Today George Osborne will announce the first major cuts in government spending for at least 20 years, and perhaps the biggest cuts for a generation. The details are not yet clear but it seems likely that some budgets will be cut by at least 25%, with social security, defence, social housing and the justice system likely to see major reductions. There are also likely to be some tax increases. Regardless of the precise details, the aim is to reduce the budget deficit and put the public finances on a more sustainable footing. The hope is that this will also help to spur a ‘rebalancing’ of the economy away from public spending and financial services and towards manufacturing and industry. The aim seems admirable. But what are the chances that it will actually work?

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How to get rid of unemployment

Unemployment is a horrible waste of people’s talents, energy and ideas. And given that the vast majority of unemployed people are paid large amounts of money in benefits, it is also a huge burden on taxpayers. Unemployment is around 8% in the UK and may well rise as cuts in government spending start to bite. At the moment we carry on tolerating this waste while we wait in vain for the private sector to start hiring again. Meanwhile millions of people are being left to rot on the dole queue, draining billions of pounds from the public purse. This is both terribly unjust as well as unnecessary. In fact it would be quite possible to more or less get rid of unemployment if we wanted to. Here’s how.

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Advice for students who missed their grades

This year there are a lot of disappointed students out there who did not make their first choice university because they didn’t quite get the required grades. Others may have exceeded their expectations and are reconsidering their options. Many are wondering whether it’s worth taking a year out, perhaps resitting some modules, and reapplying next year. But how to decide what to do? I get asked about this situation a lot so I thought I would put together some thoughts on the matter.

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Debt aversion is the new black

Imagine that one day you go down for breakfast, turn the tap on to fill the kettle up, and nothing comes out. After some investigation you discover that the water company has simply decided not to supply you with water and you have no idea of when this will end. Of course it would be terribly inconvenient. You’d have to buy bottled water at great expense, stop having baths and showers, and start catching rainfall in makeshift water butts. Now suppose one day the water gets turned on again. It would be a great relief, of course, but you wouldn’t just go back to your old ways. I feel sure that you would perhaps keep some emergency water supplies and carry on limiting your consumption of water in case it got switched off again. You most certainly wouldn’t go out and buy a hot tub to celebrate. A lurking fear that it could happen again would make you cautious for a long time. If you replace people with businesses and water with debt in the above thought experiment then you will come pretty close to understanding what has happened in most Western economies since the financial crisis began in 2007.

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