Bullish in Britain: Will lower inflation boost the UK economy?

The British pound's appreciation relative to a struggling euro means that inflation in the country is finally starting to decrease. Some economists are taking this as a sign the UK market may be turning a corner, as it signals an increase in consumer purchasing power.

Facundo Arrizabalaga/AP
British Prime Minister David Cameron speaks during a joint press conference with France's new President Francois Hollande at 10 Downing Street in London in this July 2012 file photo. Cameron's office said the leaders discussed "the economy, the situation in the eurozone (and) a number of foreign policy issues." Because of the pound's appreciation relative to the euro, British inflation has finally started to fall.

Because of the pound's relentless appreciation relative to the euro, British inflation has finally started to fall, though at 2.4% it is still not lower than the euro area average.

This is now spun by some reporters as bullish for the U.K. economy because it means that consumer purchasing power increases. But while it is good that it is acknowledged that there are positive aspects of disinflation/deflation these people make the same mistake as those who argue that higher inflation is positive for the economy.

In terms of the direct effect, a price change is a zero sum game. A seller benefits from a higher price, or in other words benefits from higher price inflation, while the buyer benefits from a lower price or a lower rate of price increase, or in other words the buyer benefits from disinflation and deflation- But since everyone are both buyers (in their role as consumers) and sellers  as workers selling their selling their services in exchange for a wage or salary and/or as investors owning the company that sells products) the aggregate effect of both higher and lower inflation will be neutral.

This is not to say that inflation is neutral if you count in indirect effects, because clearly it isn't as it can for example distort relative price something that can both have redistributional effects between different individuals and for example create asset price bubbles or dramatic exchange rate movements. The latter means that inflation will have disruptive effects that  weakens growth. But in terms of its direct effect on aggregate purchasing power it is neutral (assuming of course that terms of trade isn't changed) as an increase in inflation means higher nominal income and a decrease in inflation means lower nominal income.

Interestingly the same newspaper that published the above mentioned story about the beneficial effects that the strong pound induced decline in inflation have, also published a story about how the strong pound has detrimental effects for exporters. Which is of course an illustration that the purchasing power increasing effect of lower inflation will for the U.K. economy as a whole be cancelled out by lower nominal incomes for exporters and suppliers of exporters, just as the previous purchasing power increasing effect that the previously weak pound had in terms of raising nominal income was cancelled out by higher inflation caused by the same weakness in the pound.

You've read  of  free articles. Subscribe to continue.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.