Who pays for higher inflation?
One of the main macroeconomic consequences of Brexit is that inflation has reached a 22-month high. This is set to become worse- much worse- in the coming months. But what does inflation mean? Who pays for it? Is Scotland going to benefit from it?
On the 18th October the Office for National Statistics published their new inflation data. Having been close to zero for the first half of 2016 (until the Brexit vote), inflation has now risen to 1%, due to the fall of the value of the Pound against all major traded currencies.
The International Monetary Fund and the Bank of England estimate that inflation will rise to 3% by the end of 2017, exceeding the Bank of England’s own target of 2%. The Governor of the Bank of England, Mark Carney, argued that the inflation target will be sacrificed in order to facilitate a speedier recovery of the economy.
The devaluation of one’s currency is not a good or a bad thing in itself. What makes it good or bad is what type of economy a country has, and to which social group one individual belongs. China, for instance, was accused in recent years of devaluing the Yuan in order to gain advantage over its rivals. China has the strongest manufacturing sector in the world, and a weaker Yuan means that goods made in China are cheaper for foreigner buyers.
In other words, devaluating one’s currency is good for exports and bad for imports.
This has major consequences for the UK- which has a very different economy to China. The UK’s current Balance of Trade is -£4.7 billion, which means the total value of imported goods is £4.7 billion higher than the value of exported goods. It is not always been like that. Until the 1970s the UK enjoyed a balance of trade close to zero (1), but the Thatcherite “revolution” made the economy more reliant on the finance sector and less on manufacturing goods, which can be purchased cheaply from abroad.
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WHO PICKS UP THE BILL?
An importing country like the UK is set to be hit hard by a devalued currency. The UK imports over 40% of its food (2) and the overwhelming majority of clothes, with higher percentages of imports at the lower end of the apparel market (just check the label on your clothes).
The way inflation is calculated understates price changes and understates how consumers who only buy essentials are more negatively affected then others: people on low-income will be hit harder than inflation figures suggest. A 1% rise in inflation does not mean that all people living in the UK will spend 1% more than last year when buying the same goods. Inflation- like all economic figures- is an average. Inflation is calculated by monitoring the retail prices of a shopping basket, which is made up of items listed in the Consumer Price Index (3). Items within it include the price of a Hotel’s stay and the price of “Jewellery and Clocks”.
People on low income do not spend any money on hotel stays or jewellery though. Most of the money spent by people on low income is for housing and food costs, as confirmed by research on poverty in Britain- and by the daily experience of many. When inflation is caused by a rise in basic items, like clothing and food, as it happens to be the case just now, it means that the more you spend on basic items, the higher ‘real’ inflation is going to be for you. For instance, the “average” person spends over 30% on housing costs, whilst housing account for only 12.8% of the Consumer Price Index total. In Edinburgh, a person working full time and earning the National Living Wage will spend 35% of their income to rent a room in shared accommodation at the lower end of the market. In 2015 the price of rent rose in the capital at a pace of nearly 9% compared to the previous year (4). This happened in a year in which the level of inflation remained the same.
People on benefits will be hit even harder- the block on in-work benefits rises imposed by former chancellor George Osborne means that benefits will not rise
in line with the official figures on inflation. To sum up, people on low income are hit much harder than inflation figures want you to believe.
(3) A Brief Guide to the CPI can be downloaded from http://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/sept2016