Centre for Research in Social Policy

School of Social, Political and Geographical Sciences


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Two cheers for low inflation

Low inflation is better news than it used to be for people on low incomes

Today’s record-equalling increase of half a per cent in the Consumer Prices Index is short-term good news for the great majority of people in the UK, who have seen prices rising faster than their incomes in recent years. It increases the likelihood that after their long fall, living standards will finally start rising again in 2015.

But one thing that today’s commentaries are failing to note is that this applies more clearly to people working in the public sector, people on low incomes and to pensioners than to those whose main income is from private sector earnings.

For someone whose income comes mainly through wages, lower inflation is good for a given level of earnings, but earnings levels themselves are unpredictable, and partly related to inflation rates. So for example in March 2014 the Office for Budget Responsibility forecast inflation for 2015 at 2.0 per cent and earnings increasing by 3.2 per cent – a 1.2 per cent real increase. By December it had downgraded its inflation forecast to 1.2 per cent and earnings increases to 2.0 per cent, a 0.8 per cent real increase.  This means lower price rises but actually a slightly slower growth in real earnings.

For people working in the public sector, and for people on low incomes who rely on out-of-work benefits or in-work tax credits, the difference is that income changes have been pre-set to a large degree. This is very different from the situation up to 2010, when they rose at least in line with prices. Now, policies freezing or decreeing a one per cent flat increase in public sector pay or benefits have very different effects if inflation is high or low. When benefit increases were first fixed at one per cent in April 2013 and inflation was running at around 2.5 per cent, this represented a real-terms cut; by this April it looks like a 1 per cent uprating will be a real-terms increase. Moreover, people on tax credits have seen a freeze in the amount of their earnings “disregarded” before being withdrawn as their incomes rise. This disadvantages low income working families if both inflation and earnings increases are high, since most of the increases in earnings are clawed back by reduced tax credits (or Universal Credit, under the new system).

And don’t forget pensioners, whose “triple lock” protection is once again working in their favour. This says that state pensions will rise by the highest of inflation, average earnings increases and 2.5 per cent. If the OBR is right for 2015, the 2.5 per cent rule will kick in, with pensions rising faster than earnings and double the rate of inflation.

Whether these groups gain from low inflation over the longer term is harder to predict. If deflation sets in, a generally sluggish economy may worsen general job prospects. It will also harm the public finances in a way that further prolongs fiscal austerity: tax revenues relative to debt will fall. Looked at another way, inflation helps reduce the real value of the deficit, and without it, slow or zero increases in benefits and public sector pay may be prolonged indefinitely. Perhaps the only (tentative) good news will then be that with no inflation, even an austere government will be reluctant to continue reducing the real value of benefits and public sector pay, because this would mean actually cutting them in cash terms. But don’t assume this could never happen: if there’s one thing we’ve learned about public austerity, 2010s style, it’s that the past is not a guide to the future.



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