Page last updated at 00:01 GMT, Friday, 27 February 2009

Inflation: the hidden factor behind the downturn

Analysis
Michael Blastland
Author, "The Tiger That Isn't"

What caused the recession?

Sterling bank notes
Is it rising costs or lack of credit that is to blame for the recession?

Or is the answer obvious? Banks and bankers and regulators and debt, surely?

It's simple.

But maybe too simple. It sounds, in fact, more like a story than the messiness of economic life.

I'm not arguing that banks and debt weren't critical, far from it, but I wonder if we've forgotten something: inflation.

What makes me think so is a striking parallel with an earlier crisis in the 1970s.

The seventies were defined by economic chaos in the wake of two oil-price shocks.

The price first doubled then doubled again.

Developed economies reeled.

The very words "oil-price shock" became shorthand for an economic upheaval in the same way that "credit crunch" has today.

Irrelevant inflation?

Compare the 2000s. In this decade, the oil price first more than doubled, then more than doubled again.

Now, as then, this took several years, culminating in an astonishing spike in prices, this time above $140 a barrel, about 700% higher than the decade's low.

Convulsive 30 years ago, similar facts today seem now to be regarded as footnotes.

Can that be right? Can inflation have become irrelevant so quickly?

It is true that the oil price has come down faster this time, though it is still about double the $20-$25 a barrel that mostly prevailed for the first couple of years of the decade.

And it's true that when it comes to what economists call headline inflation - the prices you or I notice in the shops - only a few took off: food for example.

But that might be because workers and businesses took price rises on the chin in the form of lower profits and pay rises that failed to keep pace with rising costs.

They didn't try to pass the inflation on. So the pain was still there, but arguably we faced up to it more quickly, and brutally.

Hidden factor

Look further and it turns out that the sector of the economy that's suffering most is manufacturing.

Sure enough, prices paid by manufacturers were particularly affected by the oil price rise - and a doubling in the price of metals - and are still about 50% higher in the UK than they were four or five years ago.

Does this recent past really have so little bearing on the present, particularly a past that economic theory tells us is so detrimental to business investment?

There are, of course, arguments against the idea that inflation has been a large and mostly hidden factor in the downturn.

These are that rich countries have become more service-based and less dependent on raw material costs.

That is true, but only to some extent.

Can inflation really be, as one national newspaper put it recently "so yesterday", as if irrelevant to where we are?

Complex stories

Throughout 2008, I recall business people complaining bitterly about costs, seldom about credit.

That debt and credit have been real factors, there's little doubt.

Whether sufficient to explain what happened, I wonder.

Economic narratives are often just that: narratives that impose order on complicated human affairs. They are abetted by journalism that also likes its lines simple and clear.

So we talk about the story of the recession.

Perhaps we should talk instead about the stories - plural - and accept their complexity, or else we might risk missing a cause of the next problem.

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