DD309 : Doing economics: people, markets and policy - 1 Week to Go, but too busy worryng about deflation.

One week to go and after a fairly positive start pre-reading the text book in advance of the course starting, I then got too involved with the Future Learn course on Research Projects (which I hope will be worth doing) and haven't done a great deal more since. I intend to make up for this and have a good go at WEEK 1 this week and try and keep ahead.

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However another thing that has got me wondering is that everyone seems to be very relaxed about the inflation rate dropping to 1.5% (http://www.bbc.co.uk/news/10612209) in August which means either everyone knows something I don't, or I have misunderstood all the inflation modelling stuff in DD209.

If the Bank of England has targeted inflation at 2%, then why, if the government is in control of the economy, is inflation still sliding further below target. The so-called recovery from recession appeared to be built largely on the back of cheap credit and the mini-housing boom caused by 'Help to Buy'. But 'Help to Buy' has come to an end as it was causing house prices to increase ridiculously and we have been told repeatedly by Mark Carney, of the BoE, that cheap credit is also ending soon.(http://www.telegraph.co.uk/finance/bank-of-england/11121221/Pound-spikes-as-Mark-Carney-says-first-interest-rate-rise-getting-closer.html)

So if my rudimentary understanding of inflation is correct, inflation is falling because the economy is, we were taught, not at equilibrium and demand is not sufficient to close the output gap. This is hardly surprising due to most people having less money to spend or not wishing to spend due to,

  i. Austerity cuts. So less public spending.

 ii. Benefit cuts - bedroom tax, reduced benefits etc.

iii. Low quality of employment - zero hours contracts, part time work and reduced hours.

 iv. Wages having lagged inflation for some years.

  v. Tax cuts for the super rich, and their windfall unlikely to be spent on the high street.

These reasons and more means that the obvious end effect is a slow down in the economy, an economy which is already struggling with exports due to one of our main markets, Europe, also being crippled by their own recession and austerity measures.

So, my question is.....

Surely increasing interest rates will result in inflation being driven even lower and worryingly close to deflation. Further to that, does the frequent reference to future interest rate rises not simply increase people's worry about their future mortgage payments and therefore encourage them start saving for a rainy day (or the impending storm) and hence exacerbate things further through the 'Pardox of Thrift'.

We were told that an important task of government is to control inflation. However if an independent BoE won't/can't reduce interest rates to raise inflation, and in fact intends to increase interest rates surely this is not good news for inflation ( http://www.bankofengland.co.uk/monetarypolicy/Pages/how.aspx ). With this scenario heading our way I can see two possible ways out, but both will be expensive, and will require government policy U-turns.

The government can either embrace a form of Keynesian economics and embark on a program of public spending to boost the economy and raise inflation. Alternatively the government could agree to above inflation wage increases to Civil Servants, Nurses, Police, British Forces etc. and hope that the commercial sector follows suit and there then follows a carnival of unrestrained spending on the high street. Either way, baring divine intervention (and we all learned in A222 that this extremely unlikely, or to be more accurate, impossible) they will need a significant cash injection into the economy, and where is that coming from.

So can somebody who understands these things far better than me please tell me what I have got wrong, and why everything is going to be OK and that we shouldn't fear the fact that deflation may be just round the corner.

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Oh, and the StudentHome webpage still hasn't published the tutorial dates. I find this perplexing, and I wonder what effect this will have on the attendance at the first tutorial due to the extremely late notice being given.