Inflation is down so interest rates are coming down, right? Yippee! 

Except, well, no. The Bank of England Monetary Policy Committee — the very wise and serious people who decide the price of money for us — may cut interest rates, that’s true, but it’s no sure thing. British monetary policy runs like British Rail used to with the wrong sort of snow (a byword for euphemistic and pointless excuses). 

It’s the wrong sort of inflation that’s come down. The BoE’s MPC is also correct in this. It is possible for it to be the wrong sort of inflation. 

We all know, of course, what inflation is. It’s when prices go up. But economists, being economists, — these are the people who can have five opinions between three people in an otherwise empty room — distinguish more than a bit between different measures and types. 

Different measures? Well, there’s the Retail Price Index which we don’t use any more. Not unless you’re a doctor looking for a wage rise that is — for that’s what they did just recently. RPI over the past 15 years has been a lot higher than the other measures, which is why the doctors used it to claim how far their real — after accounting for inflation — wages had fallen. It’s possible to think that’s a bit cheeky.

The Consumer Price Index is the one we all do use today, and CPI comes without housing costs and with, as CPIH. It’s housing costs, not the price of houses. There are others — Personal Consumption Expenditure (PCE) for example, which reacts to changes in what people purchase, not just the prices, more quickly than CPI. 

To calculate that CPI (and CPIH), the Office for National Statistics checks the prices of tens of thousands of different things (180k prices of 700 different things) each month. This shopping basket of things we all buy is, well, things we all buy and every year there are articles about how CDs, or music players, are no longer in that because we’re simply not buying them in any volume any more. They’re not typical purchases so aren’t part of the usual inflation rate. 

That’s then weighted by how much of each we normally buy — deodorant is in there but in the percentage of the weekly shop that is normally deodorant, beer is in there but in the percentage of the weekly shop that is beer and so on. The price of beer has a greater impact upon inflation than that of deodorant for obvious reasons – one of them being that journalists don’t drink deodorant, at least not until those very final weeks. 

Which of these inflation rates we use — RPI, CPI, PCE and so on — is a matter of choice. As it happens the BoE uses CPI and the Federal Reserve over in the US PCE. This is one of those shrug differences. Well, except that no one other than British doctors uses RPI any more. 

However, we do still need to get up to five opinions and this is an important difference. We know that food and fuel prices are very volatile. It’s not just that they can go up quickly — as we’ve seen in recent times – it’s that they can also come down pretty quickly. The US had an outbreak of avian flu, the price of eggs shot up. This has a big impact on food inflation. The birds all die, new ones grow and as sure as eggs is eggs the price comes back down again. Europe has a fit of the vapours and stops buying Russian gas and the price of gas rises, but then does come back down again as the Americans send emergency shipments of the stuff. 

Fuel and food are, obviously, a vital part of a family budget — they’re part of inflation. But they don’t react in the same way to the same stimuli. Virii and Putin, to the extent of the difference there, move those prices up and, importantly, down again. This is distinctly different from the other sort of inflation that we want to both measure and do something about. 

The cure for the inflation is to take the bits of paper away

The other sort of inflation is what Milton Friedman was talking about — money printer go brrr. Or, inflation is always and everywhere a monetary phenomenon. More bits of paper floating around but the same number of things to buy with them, everything to buy requires more bits of paper — inflation. We’ve had, people might note, quite a lot of money printing going on, that’s what quantitative easing was. That second burst of it, during the pandemic and lockdown, was spent directly into the economy, there are hundreds of billions more pieces of paper around. Inflation. 

This is one point at which Modern Monetary Theory is correct — the cure for the inflation is to take the bits of paper away. That can be done with tax but it can also be done with quantitative tightening, QT. That is being done but slowly. Another bit of both MMT and also standard economics, banks create money when they lend. The sensible — the non-MMT people — say this is credit but it’s still a form of money. More of this but the same number of things to buy — inflation. 

At this point the perceptive will note that if we raise interest rates then banks will lend less money. This means less money being created — inflation will ease. We are now back with St Milt and monetarism — raise interest rates to curb inflation. Which is, of course, exactly what has been done. 

And great, eh? So we’ve beaten inflation, that’s back down to 1.7 per cent by that BoE target, CPI. So, we can cut interest rates, Yippee!

Except, well, no. Because, again, we’ve got two types of inflation here. There is food and fuel, which go up and down on their own and for their own reasons, and what we might call real inflation which is everything else and is subject to monetary policy, the supply of money and interest rates. So, what we do is have two inflation measures which take account of this little technical difficulty. 

CPI, the one we all see reported, includes that food and fuel. “Core” CPI does not include those two and is the better measure of what we should be doing with interest rates. The latest ONS inflation report: “The Consumer Prices Index (CPI) rose by 1.7% in the 12 months to September 2024.” OK, add in housing and it’s worse: “The Consumer Prices Index including owner occupiers’ housing costs (CPIH) rose by 2.6%”. And if we take out food and fuel: “Core CPIH (excluding energy, food, alcohol and tobacco) rose by 4.0% ” and “core CPI …rose by 3.2%”. Ah. 

Because:

 The largest downward contribution to the monthly change in both CPIH and CPI annual rates came from transport, with larger negative contributions from air fares and motor fuels; the largest offsetting upward contribution came from food and non-alcoholic beverages.

Food and fuel were, as usual, off doing their own thing. The other prices, the ones we think are amenable to monetary policy, to interest rates, are still well above that 2 per cent target. 

This is not conclusive, either way. That MPC, that BoE committee, gets to use which of these CPIs it thinks it wants to. So we out here cannot, conclusively, say that 1.7 per cent on the CPI will lead to an interest rate cut or not. Maybe they’ll place much more weight on the 4 per cent core CPIH, or the 3.2 per cent core CPI? Those last two do make a great deal more sense as those are the inflation rates amenable to change by monetary policy and interest rates instead of Putin and virii — to the extent those differ again. 

We can hope of course. Price setting is not a desirable thing in an economy but since the government has taken unto itself price setting for money, we can at least hope that they’ll use the right information to set it. And that CPI at 1.7 per cent just ain’t it.