19th Apr 2011 - What does inflation mean to you and me?
Apart from the obvious issue of rising prices, how does inflation directly affect us? This is how it works.
The Bank of England has made a commitment to keeping inflation at 2% using the CPI (Consumer Price Index) as its measure. The markets watch Meryn King’s team and look to them for reassurance that the rate setting is in good hands. Make a mistake and the markets pounce on it, forcing down markets and affecting currency exchange rates which in turn has a direct impact on our exports, meaning we sell more due to a change in the strength of the pound. This means more jobs and higher consumer demand which feeds the inflation cycle.
To stimulate the economy The Bank has a number of fiscal tools at its disposal. Quantitative Easing (QE) is one: the Bank prints new money to increase money flow. Money ends up in the pockets of consumers; we all feel wealthier and spend more. The flip side to this is that more spending equals more demand which pushes up inflation. Raising interest rates is intended to dampen demand by making money more expensive to borrow. By doing this people have less money to spend and demand is lowered and prices are reduced to compete for custom.
The crux of the problem lies in the fact that no matter what the Bank of England does, it cannot control non-UK inflationary pressures, such as Oil & Gas (driven by Libya crisis and the wider Middle East), Wheat (driven by worldwide crop failure) and more. I don’t profess to be an Economist but reading in between the lines it is quite clear that in the mid term inflation is here to stay.
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