The true inflation surprises

There's something really surprising about UK inflation. It's not that it's now a percentage point above target. The big surprise is that it hasn't been this far above target before. Since 1997, the Bank has never had to write an open letter to the Chancellor, which it is obliged to do if inflation drifts more than a percentage point away from target.
This is strange because economists had thought such letters would be common. Back in 1998 Charles Bean - now the Bank's chief economist - wrote (pdf):

Open Letters would...be triggered more than 40% of the time. Open Letters would be a rarity only if aggregate demand...becomes significantly less volatile, and there seems no particular reason for expecting that to happen.

But it has happened. Though it's unclear why. James Stock and Mark Watson say (pdf) it's largely due to luck. But Bill Martin and Bob Rowthorn reckon it's because better monetrary policy has made inflation more sensitive to small changes in interest rates. And inflation's also been kept down by favourable supply shocks too; the entry of India and CHian into the global economy, and rapid technical progress in consumer goods.
There's another surprise. This stability in inflation and demand hasn't given us an obvious pay-off. It's trivial that stable inflation on average doesn't mean stable inflation for everyone.
Nor is it clear that stability is improving the UK's long-run economic performance - if you believe the Treasury. It forecasts (table A2 of this pdf) that output per hour will grow 2.25% a year from now on. This is no different from the 2.22% it grew during the unstable 1986-97 period.

Comments

[AntiCitizenOne]

Anybody following the high Money Expansion, the end of the carry trade, and the large banking profits and bonus will not be suprised by the inflation figures.

[Matthew]

2.25% is not quite no different from 2.22%, which might sound like I'm being picky, but isn't this the magnitude of gain from low inflation that Robert Barro found in a study in the mid 1990s?

[dearieme]

"2.25% is not quite no different from 2.22%": even in view of the likely measurement error?

[Matthew]

Sure (although I suppose it's possible the Treasury's forecast of new growth rate is old growth rate + 0.03%, in which case it wouldn't matter), I'm just saying I remember a study in which gains that small were forecast. Looking it up its "Growth and inflation", by Barro, R, 1995, and the figures I can get from the synopsis are 10% inflation leads to 0.2% to 0.3% per year less growth.

[Matthew Sinclair]

Surely the conventional explanation would be that central bank independence has increased the credibility that inflation will be fought... classic Barro rational expectations stuff.

As to economic performance. Even if the growth gain is relatively minor inflation and instability have costs of their own. E.g. WW2 and other less melodromatic examples :)

[Dom]

It seems to me that, in an increasingly globalized world, excessive/insufficient demand is spilling over into trade deficits/surpluses rather than higher/lower inflation. Just ask the US and Germany.