The inflation hawks were wrong, but for the right reasons

This month, we’ve had a good run of news on the economy: unemployment is down, borrowing is down and inflation is down.

This should be a great encouragement to supporters of the government’s economic strategy. But for some on the right the inflation figures are actually a bit embarrassing. Given a monetary policy that’s looser than the morals of alley cat, some on the right were convinced that inflation would go up not down.

George Eaton of the New Statesman is not inclined to forget or forgive these Hayekian jeremiads:

• “Last year, as inflation rose to more than 4 per cent (it eventually peaked at 5.2 per cent last September), a band of right-wing commentators and economists demanded that the Bank of England hike interest rates in an attempt to bring prices down… A fearful leader in the Spectator declared: ‘Inflation is back with a vengeance...Britain is once again in an inflationary cycle...For how much longer can high inflation be described as a blip?’”

To rub salt in their wounds, Eaton reminds the British inflation hawks that their Keynesian arch-enemy, David Blanchflower, was right where they were wrong:

• “Others, however, including New Statesman economics editor David Blanchflower, argued that the spike was largely due to temporary factors such as the VAT increase, higher global commodity prices, and the depreciation of sterling, and predicted that inflation would fall back in 2012.”

At this point it’s worth pointing that Mr Blanchflower isn’t always right. For instance, this is what he tweeted before the good news on unemployment figures:

• “I fully expect an increase in unemployment tomorrow”

Oh well, you win some, you lose some.

In any case, the concern expressed by the right over the looseness of monetary policy – and in particular the extent of quantitative easing – is hardly unreasonable. Consider the following  from Allister Heath in the Daily Telegraph:

• “The figures make astonishing reading. Since August 1, the Debt Management Office, which is tasked with raising cash for the Treasury, has sold £34.3bn of new IOUs. During the same time, the Bank of England bought £32bn of them. The difference – a relatively trivial £2bn – is the net amount the market had to absorb. There is actually a scarcity of some kinds of gilts.”

In normal circumstances, the creation so much money by the authorities would indeed lead to inflation. However, these are not normal circumstances. The overhang of private sector debt built up under the previous government is so vast, that the deflationary impact of its repayment is offsetting the inflationary impact of QE (and vice versa).

One could argue that it’s a little blinkered of the Hayekians not to notice the highly unusual conditions in which the economy is now operating. However, exactly the same charge could be levelled at the Keynesians.

The likes of Blanchflower argue for spending increases, VAT cuts and similar measures in order to stimulate economic growth. With more money in their pockets, the idea is that consumers will start spending again. But, surely, the lesson of the inflation crisis that never was is that consumers aren’t spending whatever extra money they can get hold of, they’re using it pay-off their debts.

In other words, the inflation hawks and the stimulus monkeys are both wrong – and for the same reason.