Aviation policy should be rethought

The government should completely rethink its aviation policy and shelve plans to expand Heathrow and Stansted airports, according to an influential advisory body.The Sustainable Development Commission, chaired by Sir Jonathon Porritt, said there were big question marks over the environmental and economic arguments underpinning the proposals for British airport expansion. It warned that the government faced a wave of legal challenges if it did not hold an independent review of its 2003 aviation white paper, which sanctioned new runways at Heathrow, Stansted and other airports. It believes that a full cost benefit study should be undertaken to consider the full implications of the expansion of air travel. Read further details.

A good example of an economic activity with many private benefits but also numerous external costs (ask those people who live near an airport - I am one of them!)

Fuel prices 'keep cars off road'

It is generally assumed that the demand for petrol is relatively price inelastic, hence the increasing duty that has been imposed over the years. But we may now have reached a price that is startring to encourage some motorists to reconsider their transport options if a report by the AA is to be believed. High prices of petrol and diesel are making UK drivers think twice about travelling by car, a survey suggests. The AA polled 17,500 members, and found 27% had cut back on other areas of spending, 16% had decided to travel less by car, and 21% had done both. Petrol prices have risen sharply this year, although government figures have only shown car traffic falling 2%. The Petrol Retailers Association says that average prices could go up as much as 5 pence a litre by the weekend. Link to BBC News.

Why do you think 27% had 'cut back on other areas of spending' to maintain their perol or diesel consumption?

Food price rises 'hit UK harder'

The UK is "more exposed" to rising food price rises than its peers, adding to recessionary fears, according to a report by Ernst & Young. Its Item Club says "the implications for business are profound" - making it more likely firms will raise prices. Unlike the US which has a balance of food and France which has a surplus, the UK has a trade deficit in food. The Item Club report says that as food prices keep rising, this reduces the chance of an interest rate cut in the UK. "The danger now is that rising food world prices and energy prices will lead to excessively tight monetary policy", it says, as the government seeks to counter the rise by "squeezing domestic costs". As food and energy prices contribute 1.7% to Consumer Prices Index Inflation - which recently reached 3% - this leaves "little room" for price rises elsewhere. Input costs have risen by nearly a quarter in the 12 months to April, eating into consumers' disposable incomes. Link to article.

The government's 2% inflation target will require a 1.5 percentage-point premium on interest rates because of spiralling food and energy prices. This will lead to sharply lower growth and rising unemployment, as many as 60,000 jobs lost, according to the Item club report, which uses the Treasury model to forecast the economy. It urged the chancellor, Alistair Darling, to exclude food and energy from the inflation target or risk excessive pain for voters in the run-up to the election. Read the Guardian article.

Larry Elliott in The Guardian

In his article 'Farewell prudence, hello £2.7bn slush fund', Larry Elliot reflects on Labour's efforts to deal with the criticism of the abolotion of the 10p tax band and the political uproar it has caused. It is a solution that is too late...' The trouble is that it has taken 14 months to find this solution and it came only after the government first insisted there was no problem and then said the poor state of public finances meant only a far less generous package was affordable.' Does it stand as a credible economic policy?

The £2.7bn can now be seen as a 'political' move designed to influence the Crewe and Natwich byelection. He compares it to the last time tax giveways were used to try try to gain electoral advantage, Norman Lamont in 1992. He suggests the government's reasons for the change, quoting Alistair Darling "As I made clear at the time of the budget, it is right and sensible to allow borrowing to rise and investment to be maintained as the economy slows. Debt is lower than in the past and low by international standards. Our fiscal policy, like our monetary policy, is designed to support stability in these uncertain economic times generated by the turbulence in world financial markets and global commodity price inflation."

Elliot thinks this is unconvincing, outlining the the two views on fiscal policy: 'One is Keynesian: the idea that when times are tough, governments should do more than simply allow borrowing to rise as a result of falling tax revenues and rising welfare payments; instead they should raise spending or cut taxes to boost activity. The other is called Ricardian equivalence: attempts by governments to borrow their way out of trouble are doomed to failure because individuals know that there is no such thing as a free lunch, with today's tax cut turning into tomorrow's tax increase. As a result, they don't spend the windfall from the state, but save it for the day when they have to pay it back.' The recent $150bn worth of tax rebates in the USA was designed to reinforce the effects of lower interest rates whereas the £120 per taxpayer will have significantly less effect. Read the full article here.

Inflation ...all the fault of the MPC?

According to an article in today's FT, 'the increase in consumer prices index inflation since mid-2007 can be largely explained by rising global prices for food and energy. The deeper question, however, is why these have not been offset by slower rises or falls for other products and services, as would be expected if monetary policy had been correctly calibrated to meet the inflation target.' The MPC ' allowed excessively loose monetary conditions to develop between 2005 and 2007. Bank rate was cut inappropriately in 2005 and maintained below its neutral level until 2007. During this period, investors’ risk appetites significantly increased. The result was a prolonged period of buoyant money and credit expansion.' They discussed rapid money and credit growth in 2006 and 2007 but'played down the dangers'. The upshot is that official neglect of monetary warning signals has once again been followed by 'an unexpectedly large rise in inflation although the details of the transmission mechanism differ. In effect, loose domestic monetary conditions have accommodated or even supplemented the inflationary impact of rising global costs.' It is also suggested that there is liitle scope for further interest rate cuts in the near future. Read the article.

Government 'should change inflation target'

Consumers will be "crucified" unless the government changes its inflation target, a leading economist has warned. Peter Spencer from the influential Ernst & Young Item Club is urging ministers to change the 2% inflation target used by the Bank of England. He warned that interest rates would have to stay at 5% if inflation is to be brought down to 2%. He added that keeping interest rates at their current level would hurt hard-pressed households. Professor Spencer said consumers were paying the price for an inflation target that had become unrealistic given the volatility of oil and food prices. He called for the Bank of England's remit to change so it focused on "core inflation", a measure that excludes food and energy prices and is used in the US. Read details here.

David Smith's piece in the Sundaty Times also makes an interesting read, especially the divergence between base rate and other interest rates in the economy, those that have a real impact on economic activity. Link to article. Geoff Riley provides a summary of the key points on the tutor2u blog. Link

Does the CPI reflect the 'real' level of inflation in the economy?

A view from France

Greater competition, lower prices, must be welcomed by consumers. Not necessarily so, if the example of France is anything to go by. Many French consumers, unhappy at rising prices, inflation at a 17 year high and lower prices elsewhere in Europe, have reacted unfavourably to a proposed new law enabling more hypermarkets to be built to challenge local monopoplies and greater freedom for them to negotiate prices with suppliers. A poll showed that less than half favoured more competition as a solution to their concerns but rather a reduction in sales tax and a rise in the minimum wage.

Unlike the UK, hypermarkets are not allowed sell pharaceutical products, despite their claims that they could do so more cheaply. Despite a legal challenge, ' the pharmacists' monopoly remains—with Mr Sarkozy himself ruling out any change on the ground that pharmacies are not a business but a “public service”. ' Read the full article here.