Will Inflation Mean Higher Interest Rates?

There has been a lot of fuss recently about rising inflation. Each months' figures have been greeted by gloomy news stories portraying the upward drift of inflation as a problem. The odd thing is that the rate of inflation is still below the the government's target. Not one of the news stories I've seen or read has pointed out that an inflation rate two percentage points below the 2% target is a much bigger problem than a rate two percentage points above.

Will the Bank of England raise interest rates to slow inflation? Obviously the Bank will not want to push inflation down below today's level when it is below the target. The fear here is of inflation continuing to rise. The fall in the value of the pound from the middle of last year is the main reason for expecting inflation to rise. (Indeed, the exchange rate may also explain why the news reports are so gloomy. Some people are on the lookout for bad economic news to support their view of the world after the events of last June.)

Action by the Bank takes about two years to have full effect. Today's interest rate decision will influence inflation in two years time. A rise in import prices will push up the rate of inflation today and then disappear from the inflation figures in one years time. Of course the fall in the exchange rate also takes time to impact inflation, because firms absorb some of the increase in their costs and because some prices are fixed in contracts.

The conclusion is that a rise in interest rates now would have the effect of slowing inflation at the point when it would be slowing anyway. The result could be to push the economy into deflation.

I don't expect the Bank to make any serious change to interest rates in response to the exchange rate.

What would induce a rise would be if wages  began to rise significantly. Particularly if it looked like firms were paying more because labour was in short supply. Despite the gloom about stagnating incomes, we might be closer to that point than we think.

Labour's Economic Policy Commission

I've been appointed to the Economic Policy Commission as part of my work on Labour's National Policy Forum. The Commission held its first meeting in Westminster in January.

Here is the report I wrote for the CLP:
http://www.labourinternational.net/policy_commission_on_the_economy_gets_down_to_work

Political Economy and Trade Deals

Trade agreements are in the news at present; mostly because commentators think the UK is desperate for any deal it can get. I shared some thoughts on the political economy of trade deals on Left Foot Forward originally published on 27 January 2017.

Why there’s no such thing as a quick trade deal



How easy would it be to agree a quick trade deal? Do negotiations need to drag on for seven years or more? Can a UK-US trade deal really be done in three months? If trade is a win-win, agreement should be simple.

There are two problems. Firstly the economics of trade deals are straightforward; the political economy is not. Secondly, modern trade deals are mostly not about trade. They are about the free movement of capital, the protection of intellectual property rents and the subjugation of regulatory policy to commercial interests.

Political Economy

The key economic fact is that the benefits of trade come from imports: consumers have more choice, cheaper goods and services become available and resources are released for more productive use. Exports, according to economists, are needed to pay for imports.

In trade talks, by contrast, the aim seems to be to promote exports. Negotiators reluctantly accept imports as the price of access to export markets. To liberal economists trade negotiations are a game where delegates pretend to care about exports when in fact they want the benefits of imports.

Political economy explains the paradox. Consumers seeking more choice or cheaper products have little power. Firms which might employ the resources freed by imports have less power than existing incumbent producers.

Incumbent firms have developed their business strategies based on a competitive advantage that wins extraordinary profits. For some trade offers the capacity to extend their competitive advantage into new territories. The more successful incumbent firms are, the greater their influence will be with governments and trade representatives. They can point to the jobs and tax revenues generated by access to new markets. Thus exports become the focus of attention.

Some incumbent firms may be threatened by competition from more efficient foreign producers. While their arguments have less appeal to policy-makers than those of successful companies, it does explain why certain favoured sectors are often exempted from trade deals. Agriculture is the obvious example.

Deals should not be called “free trade” deals. Most agreements are a mix of market opening and protection driven largely by the power and influence of incumbents.

Non-Trade Trade Issues

Protection is evident in some of the non-trade issues in modern trade agreements. Intellectual property rights were a major item in TPP, the US-Asian deal recently abandoned by President Trump. IP rights are a source of market power and so of extraordinary profits. US firms were keen to extend the generous protection offered by American rules to Asian countries.

The I in TTIP stands for investment and created one of the most controversial problems for the US-EU talks. People making inward investment decisions want to minimise the risk of their capital being appropriated or their contracts not being honoured. Special arrangements to settle investment disputes have been included in many recent trade agreements.

In countries where the rule of law is well established, courts are independent and corruption is low this should not be a concern. In fact the reputation of Britain’s courts is a source of comparative advantage much valued by the finance sector among others. Investor protection clauses are not needed in deals between advanced democratic countries.

Government procurement is another item on the agenda of modern trade deals. Government purchasing can favour domestic suppliers and so act as a form of protectionism. Equally, such purchasing can be a major tool of industrial policy not just supporting favoured sectors but also to encourage investment in innovation.

From a trade perspective, standards and regulations are seen as non-tariff barriers. For example the EU ban on growth hormones in beef production was seen by US producers as a trade barrier. The EU saw the application of the precautionary principle and the dispute was taken to the WTO.

More recent deals have sought mechanisms to harmonise standards. The problem here is that rules designed for consumer safety, public health, environmental protection and so on can all impact on trade, but they need to be set through mechanisms which are democratically accountable not frozen in trade agreements.

It is significant that when the EU created its single market it did not just have a court it created a parliament as well.

Easy

Trade deals might be easy if they were just about trade. Traditional issues of tariffs, quotas and subsidies have been joined by a vast new agenda of complex issues. With traditional barriers to trade already low, some claim that the future benefits will come from removing non-tariff barriers.

Economic analysis shows that these benefits are tiny. The extensive agreement which the EU was seeking with the US included all of these new issues. Its expected impact on the EU economy was an eventual increase in GDP of 0.5 per cent, according to the EU’s own analysis. To be clear that is not an increase in growth of 0.5 per cent but an increase after 10 years equal to about two months of growth.

Even tinier is the expected benefit of the ‘comprehensive’ agreement with Canada. The EU forecast an eventual increase in GDP of just 0.02 per cent to 0.03 per cent .

The secret to a quick trade deal is to limit it to trade. The more linkages there are with other issues the more difficult become the trade-offs and the longer the process will take.

Jos Gallacher represents Labour International on the National Policy Forum of the Labour Party.