Mortgage Advice

Reasons for Low inflation in the UK.

Low inflation has important implications for interest rates and hence mortgage payments. Low inflation enables the MPC to keep interest rates low. Despite recent rises in UK interest rates, long term interest rates are much lower than in the early 1990s when interest rates reached 15%. It is also the case that low inflation is a global phenomena. However, the UK has seen one of the most marked improvements in inflation performance. This is due to a combination of supply side policies and improved management of monetary policy.

1. Independent MPC.

Since 1997, the MPC are responsible for keeping inflation close to the government’s target of CPI = 2%. If inflation is forecast to be above the target the government then the MPC will increase interest rates. Higher interest rates reduce the growth of AD and keeps the economy growing at a rate that doesn’t cause inflation. The MPC have been much more successful than previous governments for a variety of reasons:

• Inflation Targetting: The MPC have also benefitted from using an array of economic variables for predicting inflation. In previous years, Monetary policy would often be determined by a narrow range of statistics such as the money supply. However, the money supply can be an unpredictable guide to inflation. Looking at a wide ranging collection of statistics enables the MPC to have a better overall idea of inflation expectations
• Lack of Political interference. In the post war period, the UK economy suffered from boom and bust economic cycles. Often politicians would set interest rates for short term considerations; e.g. cutting interest rates before an election. The independence of the MPC means that they are not influenced by short term political considerations.
• Expectations. Because the MPC is independent people expect inflation to be low. Therefore because they expect low inflation it is easier to keep inflation low. E.g. People don’t demand high wage increases. Firms don’t try to increase prices.

3. Technological improvements.

Improvements in technology means that firms have been able to  cut costs. For example, the advent of the internet has enabled lower costs and has reduced the underlying inflation rate. This improvement in technology is a global phenomena and a reason behind low global inflation

4. Free Market supply side policies.

Policies such as privatisation have helped to increase efficiency in the economy. This increased productivity has led to more competitive prices. Other notable supply side policies in the UK include:

• Reducing power of trades unions - helped reduce wage inflation pressures
• Lower basic rate of income tax.
• Deregulation of financial services - leading to increased competition

5. Global inflation

The effects of globalisation have helped to reduce prices. Increased competition between countries has led to lower prices, especially in manufactured goods. This is particularly due to lower prices of Chinese manufactured goods

6. Raw material prices have been low. Although some like oil have increased in recent years.