UK Inflation and Administered Prices
Ian McCafferty’s speech last month had an interesting analysis of the impact on the UK CPI figures of “administered prices” – roughly, government-determined rather than market-determined prices. When explaining why inflation may come down only slowly to target, McCafferty noted the following:
The contribution of “administered” prices – those components of the CPI index that are determined less by market forces and more by administrative or regulatory decisions – is unusually high at present, and inflationary pressures from this sector are likely to persist. Higher university tuition fees will add to inflation in each of the next three years, while on the face of it the recent increases in utility and rail prices, driven by regulatory and investment targets, will also remain a feature in coming years.
Supply-side pessimists might scoff at this kind of thing – “yet more excuses”, and they probably have a decent argument to make. McCafferty lumps energy prices in with “administered” prices, which muddies the discussion.
At least the tuition fee case seems clear-cut, though; pro-market reforms in the higher education sector should be embraced by the (mostly right-wing) supply-side pessimists! Those reforms involve moving spending from one government budget line (direct grants) to another (student loans); it is meaningless from a macro perspective that the CPI only captures what is happening in the latter.
The chart McCafferty provides is rather striking:
Ignoring the minor issue of why that forecast line is somewhat below 2% on the forecast horizon, McCafferty is happy to admit that a large part of that sub-2% inflation is coming from “administered prices” rather than supply pressure on the market prices. He explains:
Of course in the long run, inflation is a monetary phenomenon, and relative prices adjust to the monetary stance. But the upward pressures on both administered and food prices place a high burden of adjustment on other categories of the CPI basket, if, on average, prices in aggregate are to rise in line with the 2% target (Chart 17). To achieve this, on current projections, the prices of other components of inflation would need to rise over the next couple of years by no more than 1-11⁄4%, historically low for these components. As such, it is likely to take time for these other prices to make the necessary adjustment.
I got briefly excited when I read that paragraph. It could be read as a clear admission that UK monetary policy is much too tight, and is constrained by the inflation target. But then I turned the page, and he stopped there.
a) this is a “cry for help” from at least some elements in the MPC who don’t think targeting 2% inflation is optimal at the moment, though are unable to say so explicitly. Or,
b) the MPC are preparing to use “administered prices” as an “excuse” to ease policy at some point soon.
Equally, this could be the idle musings of an inflation hawk. The MPC does not need an “excuse” to ease; when inflation is forecast to be below 2% on the forecast horizon, policy is tight by definition.