Inflation proves tricky

You probably carry around a persuasive piece of proof: a small black box, about the size of a pack of cards, with which you can summon knowledge from every corner of the world in an instant. A modern smartphone would indeed have seemed like wizardry in 1968, half a decade before the first mobile phone call.

Reading this week’s news from the International Monetary Fund (IMF), it struck me that there’s a corollary to Clarke’s law: any sufficiently advanced hypotheses may seem indistinguishable from mumbo jumbo.

That, at least, seemed to be the reception given to the IMF pronouncement this week that central-bank interest rates will soon return to pre-pandemic levels.

One wag said the IMF’s forecast seemed less likely than a personal visit from the Easter Bunny.

Of course, there is more to the IMF’s prediction than the notion that we are in the middle of a blip on an otherwise smooth line.

Reading the IMF study, the suggestion that base rates will return to very low levels is framed more as a warning than reassurance.

The IMF’s experts have plotted a variety of trends over the past 40 years and concluded that the base rates required to foster a stable, growing economy – neither inflationary nor recessionary – have fallen steadily over the years. The report puts this trend down to global forces such as the increasing prosperity of emerging economies, as well as changing demographics and slowing productivity growth in the western world.

One of the problems created by low base rates is that it robs central banks of an important lever for responding to future crises. Which means sustained low rates may encourage further bouts of economic instability.

As the IMF report warns: “Because nominal rates cannot fall far below zero […] this could limit central banks’ ability to respond to negative demand shocks. Thus, debates about the appropriate level of target inflation […] could re-emerge.”

In other words, it might be considered helpful – for long-term stability – if the government were to rethink the inflation target it gives to the Bank of England, which has been set at 2% for 20 years. This in turn would ease any obligation to return to pre-pandemic base-rate levels after inflation is tamed.

Whether any of this comes to pass depends on whether the IMF has identified a real trend or has been hoodwinked by misleading data.

Clarke’s law of technological magic was founded on science, whereas economics is at best a social science (or, to the more sceptical, not a science at all).

Whether we think the IMF is talking sense or mumbo jumbo depends very much on our own expectations. Hence the small number of people disputing its other headline claim this week: that the UK’s growth will trail other G7 nations for the rest of the year.

Beating that forecast, it seems, really would require some kind of magic.