Inflation in the UK
The latest inflation rate figures for February 2018 have seen a fall from 3% to 2.7%. This disinflation has occurred for a number of reasons. The effect of the significant fall in the exchange rate is no longer being felt as the higher import prices fade out of the measurement of inflation. Food, transport and prices for accommodation such as hotels have fallen.
The growth in wages has been below inflation in recent years. However, the economy is operating at close to full employment or FE, as illustrated using a Keynesian LRAS diagram. With unemployment in the UK at 4.4% in February 2018 we are likely to be operating at close to point B. This has partly been caused by an increase in consumption, leading to a shift to the right of the AD curve from AD1 to AD2. This is evidenced by the fact that unemployment is at a 42 year low in the UK, a significant improvement from just five years ago. Therefore, the UK economy is likely to face inflationary pressure, suggesting that interest rates are set to rise again, from their current figure of 0.5%.
This is particularly true as firms struggle to find skilled workers, with over 800 000 job vacancies yet to be filled in early 2018. This excess demand for workers has led to wage rates being bid upwards. Therefore, real wage rates are likely to be positive in the UK economy for the first time in a number of years. With the economy operating at full capacity it is likely that we will see some form of contractionary monetary policy in the near future, as the MPC raises interest rates to counter inflationary pressure.
The Government has just negotiated an NHS 6.5% pay rise over 3 years. This is below the current inflation rate of 2.7% so will help to reduce inflationary pressures caused by the public sector. This is significant as 1.3m workers are employed by the NHS. Therefore, this will help to constrain cost push inflation.