Trade off between inflation and growth is now for the birds
The trade off between taming inflation by hiking rates at the expense of growth now seems for the birds.
The economy is headed for a tough time, most likely a recession, regardless of what the Bank of England does.
The UK’s present conundrum is one of the best examples in modern history of just how damaging uncontrollable inflation can be to the health of an economy.
A layman would ask: surely it’s great that businesses are getting more money for their goods?
While some firms are undoubtedly benefiting from higher prices (see Shell posting its best underlying profits ever off the back of soaring energy prices), price instability injects uncertainty into the business environment, which is ultimately damaging for investment, spending and living standards.
Businesses don’t know how high their costs will be in the coming months, making it harder to set prices.
Without knowing how much their costs will be, how will they know how much to raise wages by?
If they undershoot pay rises, households are left holding the bag.
Demand typically falls in response to living standard shocks, resulting in firms (at the margin) being unable to cover costs, prompting a market shake out and weaker activity.
Cooling growth reflects the “adverse impact of the sharp rises in global energy and tradable goods prices on most UK households’ real incomes and many UK companies’ profit margins,” the Bank said today.
The only way out of this quandary is to shake inflation out of the economy.
This will either happen on its own through demand naturally receding or the Bank suppressing demand by rapidly reining in accommodative policy.
The former will take longer, the latter will be quicker (but more painful).
Most tightening cycles end in a recession. Expect this one to be the same.