Sustained above-target inflation reduces the value of your money

In 2008/9, CPI inflation was more than one per cent above the government’s 2 per cent target between May 2008 and February 2009.  During that period, inflation in the actual cost of living (i.e. the RPI index, rather than the target variable, CPI, which is not a measure of the cost of living – contrary to much confused commentary – but a policy index (like the old RPIX)) peaked at 5 percent in September 2008.  But the episode was short-lived and followed immediately by deflation.  So in fact the cost of living in October 2009 was less than that in June 2008.

The policy index CPI measure of inflation went more than one per cent above target again in January 2010, and has stayed there ever since.  During this 2010/11 period of elevated inflation, by contrast to the brief 2008/9 episode, the cost of living (RPI) has risen by 7.7 per cent.  If RPI has risen at the old RPIX target of 2.5 per cent per annum, then over the period the cost of living would have risen by 4 per cent.  (If RPI had been 2.8 per cent, roughly equivalent to the CPI target of 2 per cent, then the cost of living would have risen by about 4.5 per cent.)

So that means that the period of sustained well-above-target inflation has meant a rise in the cost of living some 3.1-3.5 per cent more than if inflation had been kept to target.  Sustained above-target inflation is a sustained eroder of wealth.

That does not, of course, mean that temporary spikes are irrelevant, either.  In May 1978 annual RPI inflation was 7.7 per cent – not really so terribly far above the 5 per cent of the past twelve months.  In May 1980, less than two years later, it was 21.9 per cent.  In May 1983 it was down to 3.7 per cent.  Yet no-one (outside the outer fringes of Thatcher-hating-dom) thinks we should ”look through” the “temporary” spike in inflation of 1979/80.

But it does mean that the inflation of 2010/11 has already been a lot worse than that of 2008/9.  And that is before we find out whether it will really magically vanish when the economy recovers, as the Bank of England and others hope-against-hope.