The Ghost of Iain Macleod

The publication of the Bank of England’s quarterly inflation report was sobering reading yesterday. A 3.7% rise in inflation prompted the usual exchange of letters between the Chancellor and the Governor of the Bank. The fear must now be that interest rates, the traditional if blunt instrument way of controlling prices and spending in this country, will have to rise.

My view all along has been that the pump priming of the economy, with historically low interest rates and quantitative easing, was likely to see a return of inflation sooner or later which could lead to an interest rate rise. However, I thought that interest rates were more likely to rise in order to underpin UK Government bonds which are coming under increased pressure. Now I’m not so sure.

Certainly the minutes of the Monetary Policy Committee meeting will be very interesting reading in thirteen days time. Up until now the MPC has been voting as a solid block in favour of holding interest rates at historically low levels in order to help re-inflate the economy, but I wonder whether we will see anyone break rank in turn causing a domino effect on the MPC which could ultimately lead to an interest rate rise.

The danger of course is that in trying to control inflation and support Government bonds we reduce household consumption and send us back into recession by making us all pay more for our mortgages. This is what the late Iain Macleod called a stagflation situation.

I’ll let him describe it in his own words. Speaking in the House of Commons on November 17, 1965, Macleod, later to become Ted Heath’s first Chancellor before his untimely death after only a month in office, said: "We now have the worst of both worlds — not just inflation on the one side or stagnation [of the economy] on the other, but both of them together. We have a sort of 'stagflation' situation.”

PS: There was a very interesting interview with Nouriel Roubini the American economist which can be viewed HERE. Roubini’s view is that the crisis is not yet over but has metamorphosed from a private sector debt problem into a sovereign debt (ie. Government debt) problem directly due to the bailout of the banks.