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Anglo-Saxonia run and run-and still beat inflation?
A funny thing happened last year. The American economy completed its eighth year of non-stop growth- so did the UK. And so in fact did most of the Anglo-Saxon world. This all happened in spite of grim forebodings about stock market bubbles and overheating; in spite of the Asian Crisis which saw Japan's stagnation for the past decade erupt in general Far Eastern collapse; and in spite of acute malaise on the European continent which saw a recession in 1993, slowdowns in 1996 and 1998 and average annual growth in the Euro-zone since 1992 of 1.9 % against America's 3.5% and our 2.8%.
In short Anglo-Saxonia has prospered while Rhineland and Keiretsu capitalism have faltered. Nor has there been any compensating difference in inflation performance, at least not one that anyone would be proud of. Inflation has been low- in the 1-3% range- in the Anglo-Saxon world; and yes worryingly lower in Japan where deflation has been spotted, with some of the same symptoms occasionally sprouting in Europe.
All this has produced commentary and theories. We have had on the one hand the Death of Inflation; the closely related New Paradigm; the renewed talk of Euro- and now Japano-sclerosis. On the other we have had the old-time prophets of bubble-laden doom- usually asserting that the whole of the Anglo-Saxon phenomenon has been inflated by generous credit expansion that has flowed not into prices but into asset prices. Share markets have therefore been nicely balanced by two-way money flows: the New Age optimists have been buying Anglo-Saxons and using weakness as an excuse to get further in while the old-time prophets have presumably been selling Anglos and buying Japanese and Euro shares. Some optimists have also been buying the latter on hope of reform. This has indeed created a general share bull market. But evidence of that credit expansion is hard to come by; the standard broad money aggregates show only moderate growth in most countries (US M2 is growing at 6%, UK M4 at 3.6%). Much of the old-prophet diagnosis is reverse engineering from asset prices; they are 'high' and so money growth must have been high, but is somehow 'distorted'.
Until recently the missing evidence has been on productivity. But that has now started to come in for the US where the statisticians have been busy trying to get to grips with the new economy- measuring computer quality, allowing for software as a capital item and so on. Ordinary labour productivity growth since 1995 has doubled to nearly 3%. On top of this there is the falling cost of capital goods (50% of US business investment now being in computers); were one to measure this properly it would be seen to be contributing a further massive slug to productivity growth. Consider the following definition of capital cost (inspired by Cambridge UK in the 'capital controversy' with Cambridge MIT in the 1950s): what you need to spend on capital goods to keep your business output constant (imagine you were leasing all your equipment and just paying interest and depreciation on the gear you need). With computer prices (inflation-adjusted) falling at 20% a year and responsible for 50% of capital spend, one would say that properly measured capital costs are falling by 10% a year; even as conventionally measured by the statisticians brought up on Cambridge MIT (who measure capital as chunks of depreciated metal, valued at their original prices updated for inflation to some common year's price level) they are falling smartly.
Such figures can no longer be dismissed; and there is no reason to disbelieve the following commonsense story. As a result of the high incentives available in many parts of the Anglo-Saxon world, especially America, there has been a surge of innovation in information technology, whose ramifications are still in their infancy. This burst in productivity growth has driven growth in the 1990s, facilitated by an accommodating monetary policy- a classical recipe that would have also occurred under the gold standard under which rising goods supply driving down prices and raising the relative price of gold would increase the supply of gold. The difference today under central-bank-printed money is that the extra supply comes quicker, so preventing prices from falling. The High Priest of this cautious accommodation has been Alan Greenspan, who has refused to be panicked by either the Old Prophets or the New Paradigmers.
Should we go further and pronounce the death of inflation? The redoubtable duo Deanne Julius and Roger Bootle would have us do so. They are not denying that inflation is basically due to printing money; rather they are arguing that in the modern world of fast productivity growth it is politically easier to resist demands to print excessive amounts of money. The vested interests that bay for lower interest rates are generally sated with good news- unemployment is low, profits are growing, even manufacturing finds a ready transitional home market to smooth its decline in the face of super-low wages in the world's Chinas.
But this theory does not account for low inflation in Germany or Japan where unemployment is high and these vested interests are very unhappy. Could it not be merely that we have all, in the rich countries of the world, discovered by bitter experience that printing excess money buys little even in the short run except higher inflation? If so, inflation is indeed dead, but because we want it so; our central banks have orders from us to keep it so. As measuring the money supply is harder and harder in a world of competitive financial markets, we instruct them to target interest rates directly on inflation, in a pre-emptive spirit. If that results from time to time in a bit of 'over-tightening', that is the price we know we must pay to keep the inflationary genie in the bottle. Thus, yes, inflation is dead- but not because productivity is growing fast, which it also is, but because our Monetary Policy Committee was under our orders willing to raise interest rates in the last few months, regardless of the cries of pain from various parts of the body politic. Yes, Plaid Cymru and Scottish Nationalists, please take note. UK inflation is not good for Wales or Scotland either.
Patrick Minford is professor of economics at Cardiff Business