Inflation and human psychology

boj inflation

Economics is a notoriously unreliable science for predictions. My take on this is that this is due to Economic forecasting being based partly on empirical numbers (which can be quite well predicted), but also on human behaviour, and there is the rub.

As a favourite saying goes, “business is simple, people are complex”, and human behaviour (aka “consumer sentiment”) drives so much of economic activity.

So, today an example of a central bank looking to influence consumer behaviour around inflation.

Recently, the Bank of Jamaica released some fun videos explaining why a little inflation is a good thing.

First, one of their videos, then a take on this from NPR, and then some closing thoughts around human behaviour, inflation and even Brexit.

Next, the NPR take, from Darian Woods from NPR’s Planet Money podcast:

“Here’s the problem – keeping price inflation low. Jamaica has struggled with inflation over the years. The Caribbean nation started printing its own currency in the 1960s. Since then, the Jamaican dollar has lost more and more of its value. In the 1990s, price inflation even got past 70 per cent annually. We all know this is bad. In the past few years, inflation has come down, and the central bank wants it to stay that way. But an important part of keeping it down means convincing everyday Jamaicans that it’s going to stay down. It’s a public relations problem.

Tony Morrison, he’s the head of public relations for Jamaica’s central bank, and he knows inflation is fueled by this virtuous or vicious cycle. If people think prices are going to rise a lot, they’ll spend their money faster, further speeding up inflation. If they think inflation will be low, that in itself will help slow inflation. Economists call this anchoring inflation expectations. So last year, Morrison was thinking about this problem. One more dry speech from the bank’s governor wasn’t going to cut it. He had a different idea – an extremely catchy song.”

I love the idea of using catchy videos to anchor inflation expectations.

Nice work Tony Morrison and BOJ !

Now, a couple of additional thoughts.

First, a writer and student of economics I love is Tim Harford, who recently wrote in a post titled “Why inflation is good for us“:

“It is surprisingly difficult to find any serious costs to low levels of inflation. In contrast, the benefits are easily stated: more room to stimulate the economy in a recession, and more room for real wages to adjust if they must. Olivier Blanchard, during his time as chief economist of the IMF, even floated the idea that the inflation target should be 4 per cent, not 2 per cent. He is by no means alone in that opinion. Like a low dose of aspirin, a low dose of inflation is unlikely to do much harm — and it can prevent an economic heart attack.”

Now, both Tony Morrison at the BoJ and Tim Harford recognise that too high inflation (or even hyperinflation) is NOT a good thing, but I find it interesting that they have to explain that controlled and low inflation is actually a good thing for the economy and that people tend to feel that only very low or close to zero inflation is intrinsically good.

Again, great job by the BoJ in simply explaining why low and controlled inflation is good.

Now, in closing, I noted at the top about economic forecasting being about both numbers and behaviour.

I am often asked what I think the economic impact of (fast looming) Brexit will be. My answer is simple. Recession.

I don’t have to study the numbers, simply behaviour. The gaping void in political leadership across the board in the UK around this massive issue has resulted in a great loss of confidence across the country. Loss of confidence leads to a slow down in consumer spending and borrowing, which then creates a vicious circle including loss of revenue to businesses, so a loss of jobs due to layoffs, plus loss of confidence in lending institutions to support those businesses until confidence returns.

So, whatever happens on or around March 29th, the UK is in for a rough economic ride for some time to come. Yes, every downturn means opportunities for some, but it does really frustrate me that political leaders are handling this so poorly, as it means that much of the economic damage will be faced by those least able to afford it, from earnings to jobs to government budgets for health and social services.

Now, perhaps a key message that could be communicated is one I have also been sharing, that the long term underpinnings of the UK economy remain really strong and that the country will bounce back over time.

Perhaps some catchy videos from the Bank of England explaining that may help to maintain consumer confidence and so soften the recessionary blow?

Also published on Medium.