Over the last week, all the cover of the papers in the UK had the same image: a red box that symbolised the presentation of chancellor’s George Osborne 2015 Budget. But what the covers didn’t show is the form of manipulation that it hided within, by consciously ignoring information about the realities of the country in the document, as it does with the coverage of the inflation numbers.
It is well commented the main intention of the presentation of the Budget is to gain voters for the general elections. First of all, due to the fact that it was presented far after the beginning of the fiscal year coincidentally less than two months away from the general elections but also for the promises and good numbers it holds.
The BBC has made a very useful list of the Key Points of the document, in which they include the data of the state of the economy in the country, which appears under the “Executive Summary” of the Budget. This reveals the numbers of growth and actual state of the UK, all positive, and beneficial therefore to the party that drove the country to such optimistic situation.
It opens with the fact that “The UK had the fastest growth among G7 economies in 2014, employment has reached its highest ever level, and inflation is at a record low.” Impressive, indeed, especially because even things economically seen as negative, are stated in a way that makes them suddenly something good: Mr Osborne, having a low inflation is not something to be proud about!
Of course, by stating it like that, covering it with the other data that actually looks promising, it becomes one more of the facts that favours the Conservatives. But, it was of course a coarse movement of manipulation, directed to the vast majority of the population who are not trained as economic experts (like me).
So, why is a low inflation negative? After all, the government of the UK says in the Budget that a low inflation is good news because “lower fuel and food prices are welcome news for households, boosting real household incomes and helping family budgets stretch further”; and isn’t this true?
According to The Economist, central banks consider inflation should rise 2% a year, a slow ascent that can go unnoticed for consumers but can be very helpful for the overall economy since it keeps economies away from deflation and the choices it brings: hoarding cash, delaying purchases and the effect of freeze payments (usually the pay freeze due to unproductivity is a 2% cut, so with a 2% inflation rate it would be unnoticed and that would be an incentive for the companies to invest their earnings).
In the UK, as the Executive Summary of the Budget states, “the government’s long-term economic plan is delivering stability and growth, in the face of rising instability around the world. At the end of 2014 the employment rate was at its joint highest level ever and in January 2015 inflation was at its lowest rate on record.” It is indeed projected to fall to 0.2%, possibly marking the return of deflation.
Deflation sounds more worrying, doesn’t it? But, why?
The main problem with deflation is its effect on interest rates. The interest rate is what reflects the price of consumption today relative to consumption tomorrow. This means, when interest rates are high, savings are worth more tomorrow, and when interest rates are lower, they are worth less.
The real interest rate, though, is calculated by subtracting the expected inflation from the “nominal rates” (the return in money terms, i.e. the rate advertised by banks). If the nominal interest rate falls below zero, it would mean a reduction on saver’s bank balances every month, and so people would withdraw their deposits from banks and put their money under the bed, the eternal shield against inflation. So, inflation has to maintain the real interest rates in the right level, so they don’t fall far enough to boost demand and perk up prices.
Another problem with deflation is that it increases the burden of debts, since borrowers are less likely to save than lenders and therefore demand is sapped overall. Also, it increases rigidity in the labour market (due to the freeze of 2%, as talked before).
Of course, the Budget was not written by economic amateurs and further, in the deepest parts of the document, the government gives an explanation for its low inflation, for those that know it isn’t really such a great thing as they said in the Summary: “inflation was 0.3% in January 2015, down from 0.5% in December 2014. The low inflation recently experienced by the UK has mostly been driven by global factors, notably the sharp fall in oil prices and the decline in food prices. The Governor of the Bank of England has set out that three-quarters of the movement in inflation relative to the 2% inflation target has been caused by food, energy and other goods prices.”
Oh, so they knew.
–Budget 2015, HM Treasury (March, 2015).
–Key points of Budget 2015: At-a-glance, BBC News (18th of March, 2015)
–The high cost of falling prices, The Economist (21st of February, 2015)
–The Economist explains: Why deflation is bad, The Economist (7th of January, 2015)
[Special thanks to the latter, I took the liberty of paraphrasing a couple of their paragraphs, due to my limited knowledge on the matter, and the desire to explain it well.]