ECONOMICS: High CPI inflation is simply reflecting the rapid escalation of wages and salaries - a manifestation of an equilibratin mechanism at work
According to the latest published data, the annual rate of consumer price index (CPI) inflation accelerated from 3.8 per cent to 4.9 per cent between November and January. Over this same period mortgage interest rates fell.
Excluding this effect and focusing instead on what economists call the "core" rate - a better indicator of the underlying position - reveals an acceleration from 4 per cent in November to 5.5 per cent in January.
This 1.5 per cent point jump exceeds by some distance the acceleration in core inflation recorded in any two-month period between mid-1999 and the end of 2000, when the air was blue with dire warnings about the damage that a rising inflation rate might do to the Irish economy.
Moreover, January's core rate of 5.5 per cent is only slightly lower than the 5.9 per cent peak reached in the 1999/2000 cycle.
Despite all this, the current run-up in inflation has prompted relatively little comment and only the mildest expressions of concern.
Almost certainly, one of the reasons for this sangfroid is that when the inflation rate accelerates to the 5.5 to 6 per cent range for the second time in not much more than a year, it's not so newsworthy.
In other words, an inflation rate of 5.5 to 6 per cent today is not so much at variance with people's experience as it was in 2000.
Another reason may be that commentators have learned a little in the meantime: some of the concerns that were expressed in 2000 were misplaced or overstated. However, given the short-term prognosis - core inflation may well accelerate to 6 per cent or more in the next few months - it would be prudent to keep in mind that there might be an amount of wailing and caterwauling on this score yet.
Might such a reaction be justified? The first point to make is, at a microeconomic level, the current inflation rate is quite unwelcome. It robs those on fixed incomes of purchasing power. It arbitrarily redistributes wealth between creditors and debtors. It means, for example, that real interest rates are now substantially negative - to the tune of 4 to 5 per cent in the case of most small to medium-sized deposits.
However, when Irish commentators get into a flap about inflation, what is usually bothering them is a perceived threat to macroeconomic stability in the form of a price-wage spiral and the consequent big loss of competitiveness.
Do fears of this sort stack up? Is there a substantial risk that a rate of CPI inflation in the vicinity of 6 per cent or higher might propel the economy into this kind of situation?
To answer this question, it is important to understand why core CPI inflation is heading for 6 per cent. Part of the reason is Government tax policy - the effect of the December Budget's excise duty increases, already in the numbers, and of the 1 per cent point hike in VAT, which will be captured in the March index.
Another reason has to do with the boost to food prices that occurred early last year on the back of foot-and-mouth disease and unseasonable weather. However, these effects will wash out of the inflation rate over the coming six to 12 months.
In any event, the most important contributor to the current rate of CPI inflation is the rate of price increase taking place in those sectors of the economy that are insulated from international competition.
I estimate the annual rate of inflation is running at about 10 per cent, enough to account for almost 3 percentage points of the 5.5 per cent rate of core CPI inflation recorded in January.
This rate of non-traded inflation is reflecting, above anything else, the current very high rate of wage inflation.
So, the current high rate of CPI inflation is largely due to the tightness of labour market conditions, and it is overwhelmingly likely to recede as and when labour market conditions loosen up again, a process that appears to be underway. As such, to regard the high rate of CPI inflation as an active ingredient in a wage-price-wage spiral, and a likely cause of competitiveness loss, is to get the main cause wrong.
In other words, the current high rate of CPI inflation has little macroeconomic significance.
The phenomenon that possesses macroeconomic significance, and that high CPI inflation is simply reflecting, is the rapid escalation of wages and salaries, itself little more than a manifestation of an equilibrating mechanism at work.
Of course, there was a time when a high rate of CPI inflation per se would have had a good deal of macroeconomic significance for the Republic. That was when we possessed an independent currency and when persistently wayward inflation might have brought about a currency devaluation and, with it, fresh inflationary impulses.
At that time it made sense to worry about wage-price-wage spirals and the like but those days are gone. It is perhaps not surprising, however, that commentators' mindsets, constructed for the most part in a different era, are enslaved to defunct exchange rate regimes, not to mention defunct labour market conditions
Jim O'Leary is lecturing at the Department of Economics, NUI-Maynooth
jim.oleary@may.ie
