From the TUC

Inflation, real wages and potential economic surprises in 2012

16 Dec 2011, by Guest in Economics

After a busy week for UK economic data, today brought the FT headline ’IMF chief warns of 1930s style threats’, the perfect accompaniment to a fairly grey and drizzly morning.  I can see why Christine Lagarde is concerned – the economic data has been grim for the past few months, there are rising international economic tensions (such as the ludicrous spat between the UK and France over who’s AAA rating is least deserved) and the Eurozone’s most recent summit was very disappointing.

But closer to home – what did the data this week tell us? Leaving aside the latest grim news from the labour market, I was struck by the combination of the latest inflation and retail sales figures. Read together tell us a worrying story.

Over the past 18 months inflation has risen faster than wages causing a squeeze on real incomes which has hit consumer spending and hence depressed domestic demand. So any fall in inflation should be welcome as it should boost real incomes and hence provide a prop to consumer spending and domestic demand.

But there are some worrying signs that this might not be the case.

To start with real wages are not rising as much as falling inflation might suggest. Since peaking in September at 5.2% CPI inflation has fallen by 0.4 percentage points to 4.8% in November whilst RPI has also fallen 0.4 percentage points (from 5.6% to 5.2%) in the same period.

Sadly though we have seen a fall of a similar magnitude in average weekly earnings (total pay measure). In September they were growing at an annual rate (3 month average) of 2.3%, in October that feel to 2.0% – a fall of 0.3 percentage points – very similar to the 0.4% fall in inflation.

Indeed back in January real wages (measured by average weekly earnings growth minus RPI) were falling at an annual rate of 2.7%, on the latest data they are falling at an annual rate of 3.2%. Inflation might be coming down, but so is wage growth.

The fall in inflation then is not, at the moment, leading to an improvement in real wage growth or providing much support to spending.

In fact the opposite seems to be true.

This week’s retail sales figures showed a monthly fall of 0.4% in volume terms. As Bloomberg noted the fall in inflation has been driven by “food and transport prices as the prospect of another recession weighed on the economy”.

As the economy has weakened retailers are now engaged in a full scale ‘price war’ in an effort to hang onto sales.

Rather than a reduction in inflation supporting consumption, a fall in consumption is driving inflation lower. And real wages aren’t improving as the labour market remains very weak.

Add in the debt overhang faced by households, the weak growth of the money supply and bank lending and the prospects of a second credit crunch hitting UK banks in 2012 and you get something very close to Irving Fisher’s ‘Debt Deflation’ (his 1933 article is available here and makes for grim weekend reading).

It could be that in 2012 there are two great surprises in UK economic data – first how quickly inflation falls and second how this fails to support consumer spending.

5 Responses to Inflation, real wages and potential economic surprises in 2012

  1. Why the economy is about to get worse in 2012 | Liberal Conspiracy
    Dec 16th 2011, 12:50 pm

    [...] A longer version is at Touchstone blog [...]

  2. What Tesco tells us about inflation | ToUChstone blog: A public policy blog from the TUC
    Jan 12th 2012, 5:31 pm

    [...] Back in December I noted how the fall in UK inflation might not be entirely good news. [...]

  3. Why 2012 could be the year we start to worry about deflation | Liberal Conspiracy
    Jan 13th 2012, 11:10 am

    [...] about deflation by Duncan Weldon     January 13, 2012 at 11:10 am In December last year I noted how the fall in UK inflation might not be entirely good [...]

  4. David Laws and ‘the great democratic recession’ myth. | Coalition of Resistance Against Cuts & Privatisation
    Jan 23rd 2012, 12:26 pm

    [...] is right that falling inflation will help squeezed household budgets, but if earnings continue to fall then real wages will remain negative, ndeed the OBR say that they are set to fall throughout 2012. [...]

  5. Why David Laws is very wrong on the state of the recovery | ToUChstone blog: A public policy blog from the TUC
    Jan 23rd 2012, 12:34 pm

    [...] is right that falling inflation will help squeezed household budgets, but if earnings continue to fall then real wages will remain negative, ndeed the OBR say that they are set to fall throughout 2012. [...]

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