But isn’t that the whole point? 2pc is admittedly a somewhat arbitrary figure; so much so that nobody can quite remember why it was chosen in preference to say 1pc or 3pc. Both Britain and the US went through much of the 1980s with inflation at significantly above 2pc, and it didn’t seem to do them much harm.
All the same, there is a certain logic to 2pc. Inflation per se is bad. In a perfect world you’d have no inflation at all. Everyone would have a much better understanding of where they stood if that was the case. But this is probably unrealistic.
2pc is about productivity increases. Or, in the good times in a well functioning economy it is.
Leave aside the people on fixed incomes getting shafted by inflation bit, pensions only have 2% inflation upgrades and all that. Think about the larger picture.
People are very, very, resistant to falling nominal incomes. That’s one of the deflation worries. Falling real incomes not so much.
OK
Now think of technological change, productivity increases – they’re the same thing. This would, we hope, run at 1 to 3% per annum. It did for most of the past century after all.
OK, that means that relative prices of things are going to change – that’s also what rising productivity, tech change, mean. So too therefore will the wages on offer to people working in specific jobs and industries. And we want certain wages to decline relative to certain others – the lower productivity jobs and occupations to pay less than the higher prod ones.
But this then meets that hatred – and it is, it’s a visceral hatred – of falling nominal incomes. But an inflation rate around and about the rate of productivity increases allows changes in real incomes of about the right size while keeping nominal wages at worst static.
There is actually as reason to have 2%. It’s grease that allows the other changes with the minimum of fuss.
A couple of quotes from Scott Sumner:
“In order to achieve 2% inflation in the long run, wage growth must be held down to roughly 3%, on average. The extra 1% represents productivity growth.”
“When nominal wages grow at about 3 percent per year, inflation will average 2 percent in the long run. In that case, any deviations in the headline inflation rate will be transitory. The burst in inflation that began in 2021 went from being transitory to permanent when it became embedded in wage inflation.”
On the subject of productivity, Dietrich Vollrath has an interesting book titled:
Fully Grown: Why a Stagnant Economy Is a Sign of Success
A quote from a review of his book:
“In ‘Fully Grown’, Vollrath offers a powerful case to support that argument. He explores a number of important trends in the US economy: including a decrease in the number of workers relative to the population, a shift from a goods-driven economy to a services-driven one, and a decline in geographic mobility. In each case, he shows how their economic effects could be read as a sign of success, even though they each act as a brake of GDP growth.”
There’s a good review of the book here that breaks down the causes of the decline in productivity:
https://mattclancy.medium.com/fully-grown-a-review-a55719c6049c
Here’s a link to his blog:
https://growthecon.com/
The Greens have been demanding Zero Growth to save hte planets, so they must be ecstatic with recession.
I’m not averse to the base idea. But I do think it’s wrong. For we’ve a terrible measurement problem with output.
For example – WhatsApp allows 1 billion people to gain some to all of their telecoms for free. No advertising on it, no fee (or at least there have been times when this has been true). So, no recorded output at all. The expenses of running it are in out usual GDP figures though. When I asked Facebook they said “couple of hundred engineers”. OK, so we’ve costs, inputs, no associated output so therefore WhatsApp is recorded in GDP etc as a loss – yes, a *loss* – of productivity. But 1 billion people are getting some to all of their telecoms from a couple of hundred engineers. That’s not a loss of productivity at all. Our measurement system isn’t keeping up with the digital economy. As Hal Varian points out, GDP doesn’t deal well with free.
“productivity increases…would, we hope, run at 1 to 3% per annum. It did for most of the past century after all.”
Ah, but now we have regulations and public sector drag making all innovation a bit like wading through treacle. 1-3% productivity increase annually looks unlikely in these circumstances. We need some massive new idea to come along and give us a boost for a few years, until the bureaucrats catch up and stifle it – that’s how productivity increases work these days.
@Tim – “Our measurement system isn’t keeping up with the digital economy. As Hal Varian points out, GDP doesn’t deal well with free.”
It doesn’t deal well with anything. It’s a measure of cost, not value, yet it is used as if it were a measure of value.