COLA: the real inflationary threat

If Mervyn King is right regarding comments he made in his letter to the Chancellor Alistair Darling, then we should expect interest rates to head down after peaking sometime before year’s end. I tend to agree with him that the deflationary forces of a recession, housing bust and credit crunch will take their toll on prices as well as the real economy. But, what if he’s wrong?

If he’s wrong it will be because workers demand and receive wages that will help them keep up with the spiraling food and energy costs. The spectre of looming strikes in order to maintain a cost of living adjustment (COLA) is the real threat. And just such a threat is what the Telegraph has found in its reporting on the inflation events today.

Hundreds of thousands of public sector workers are threatening to tear up agreements and demand higher pay as the cost of living surges.

Inflation figures released yesterday were worse than expected, prompting Unison, one of the biggest public sector unions, to call for the reopening of a pay deal for 500,000 health workers clinched only two weeks ago.

Other unions said that they wanted to revisit pay deals and gave warning of rolling strikes this autumn if Gordon Brown persisted in trying to cap pay rises at 2 per cent.

Soaring food, fuel, gas and electricity prices sent the official inflation rate surging last month, wrong-foot-ing policymakers and forcing the Governor of the Bank of England to write to the Chancellor to explain how it had failed to keep the lid on inflation.
–The Telegraph, 18 Jun 2008

The one event that can trigger ever higher prices is the adjustment of wages upwards. Economists had hoped the dreaded wage-price spiral of the 1970s was not a factor, and I certainly haven’t believed it to be a factor. The wage-price spiral is what ultimately led to an out-of-control inflation rate that peaked over 20% twice within 5 years. Let us hope this type of outcome is not a factor now in 2008.

But what if it is?

Then all bets are off. Gordon Brown had better read Stewart Liff’s book on managing government employees. As for us: be careful what you wish for because the UK would certainly be poised for a very hard landing.