Zero Uk Inflation

Today it was announced that U.K. consumer cost inflation hitting zip inward February. The ONS guess that nosotros convey to perish dorsum to the 1960s for the final fourth dimension this happened. More importantly, nub inflation cruel dorsum 0.2% to 1.2%, later on 0.1% increases inward the previous 2 months. As Geoff Tily here, optimal command exercises on the Bank’s model as well as forecast say they should, as well as I discussed here why at that topographic point is an additional rigid prudential example for doing so.

The indicate I desire to brand straight off is nearly survey bear witness on capacity utilisation. I had a position out of memorable meetings amongst diverse economists as well as officials at the Treasury, Bank as well as elsewhere when the Great Recession was at its height, but the i that left me most puzzled was amongst i of the to a greater extent than academic economists at the Bank of England. It was at nearly the fourth dimension that nub inflation started rise to higher upwardly 2%, despite unemployment existence rattling high as well as rattling lilliputian signs of a recovery. At much the same fourth dimension survey measures of capacity utilisation were suggesting a rigid recovery, completely at variance amongst the actual output data. The gist of our tidings was: what the hell is going on!? It was especially puzzling for me, because I had many years before done a lot of operate amongst survey information of this kind, as well as dorsum so it seemed pretty reliable.

The job amongst the 2010 menses was that it was exceptional, as well as so inward that feel it was non that surprising to catch surprising things going on. My ain pet theory at the fourth dimension was that the fiscal crisis had made firms much to a greater extent than run a hazard averse, which made them less probable to cutting prices inward an elbow grease to gain marketplace share. Move on to today, as well as things are mayhap a fleck less exceptional. What today’s figures emphasise is that the inflation ‘puzzle’ of 2010/11 has gone away. Levels of inflation are straight off much to a greater extent than consistent amongst substantial spare capacity inward the economy. However the bizarre deportment of the survey information has non disappeared.

Here is a overnice nautical chart from the ONS, comparison diverse dissimilar measures of spare capacity.

  

What it shows is that labour marketplace indicators propose an amount of spare capacity good exterior the ‘normal’ attain from the pre-recession years. In contrast, both hours worked as well as survey based indicators (the starting fourth dimension 6 measures) propose the output gap is quite small, as well as inward i example truly positive. As this OBR newspaper shows, survey measures of capacity utilisation were suggesting a positive output gap every bit early on every bit 2012.

Faced amongst this combination of spare capacity inward the labour marketplace as well as firms reporting its absence, a macroeconomist would propose it could survive a lawsuit of high existent wages, encouraging exchange from labour to capital. Firms were fully utilising their working capital missive of the alphabet – thus no spare capacity – but had hired less labour every bit a result. However a notable feature of this recession inward the U.K. has been the high floor of labour marketplace flexibility, amongst large falls inward existent wages. One of the to a greater extent than persuasive theories for the U.K. productivity puzzle, which I outlined here, is that nosotros convey seen constituent exchange going inward the other direction.

Back inward 2010, I was reluctant to propose the survey information were only wrong, partly because of their by reliability but mainly because inflation was telling a similar story. On the 24-hour interval that inflation hits zero, I intend the declaration that these survey measures are non criterion what nosotros used to intend they measured has perish much stronger. But that even so leaves an unanswered query - why convey they gone wrong, when they worked good inward the past?