The ghost of inflation

For the past decade, the West has been relatively immune to price-/wage-inflation, despite significant expansions of the money supply and movement of various national balances from credit to debit, thanks to the deflationary effects of competition from emerging nations such as China and India. This has bred a complacent attitude that all it takes to control inflation is interest-rate policy designed to keep a cap on price-increases. The lessons of the twentieth century, which showed clearly that money supply was linked to inflation, that government interventions that caused an imbalance between the natural levels of saving and consumption were connected to the "boom-and-bust" trade cycles and that inflation, once started, could be very hard to stop, have largely been relegated in the concerns of policy-makers. Wage competition from immigrants, price competition from the East, and regular tweaking of inflation indices and interest rates are enough, so the theory goes, to make the old disciplines unnecessary.

It is probably this complacent consensus that explains why there has been so little comment on the inflationary aspects of the current dispute over NHS wages. There has been much sympathetic coverage of the below-inflation wage offer that has been made by the Government to NHS workers. They are deemed to be justified in their complaints, because a below-inflation wage offer is, so the analysis goes, a real-terms cut in wages. Nevermind that NHS wages have gone up, sometimes massively, above inflation in the last few years. And critically, nevermind that the corollary of that argument is that public servants should always receive pay offers that are no less than the current rate of inflation.

If employees feel that a pay offer in line with inflation is no increase at all, and therefore a minimum offer, then what happens as inflation creeps higher, as is happening? Wage offers track or exceed price-increases, which feeds the inflationary spiral. This is exactly back to the territory of the 1970s, and yet no one seems to have noticed.

This doesn't affect us equally. Public-sector pay demands to match inflation put pressure on the Government either to raise more revenue in taxes, which removes money from the wealth-creating sector of society and therefore stunts growth and costs jobs outside the public sector, or to borrow more, for which higher interest rates will be required, which again will remove money from the wealth-creating sector (as borrowing costs increase and disposable incomes fall) and cost jobs in the private sector. Moreover, the money created or extracted by government does not flow equally to all members of society, but flows first to people in the public sector, and only to people in the private sector as the public-sector workers spend the money that was appropriated from taxpayers. The spending of inflationary public-sector wage packages pushes up prices of consumer goods before the money has the chance to trickle down to private-sector workers, who will feel the effect of rising prices more strongly than they will feel the benefit of increased public spending. The losers from inflationary public-sector wage claims are not just those whose jobs are lost (or not created), but everyone outside the public sector.

This is a classic case of an apparently sympathetic proposal turning out to have hidden consequences that are far more serious than the problem it was intended to address. Not for nothing is inflation described as a particularly iniquitous form of taxation. The results of the inflationary periods of the twentieth century (including the Depression, the rise of totalitarianism, and the destruction of the British economy) ought to teach us never to let down our guard. But people don't just forget, many of them never understood in the first place.