But the key question is, if inflation at today’s low levels indeed spells trouble or is overhyped?
First of all, how do we measure inflation? Simply put, The Office for National Statistics (ONS), every month, selects about 700 different items in a virtual shopping cart, both from the goods and services sectors, and collects a number of prices for each item to get to an average price. Items in the ‘shopping cart’ will be things we use and buy every day, such as fruits & vegetables, clothes, and petrol as well as bigger items like computers, washing machines and cars.
If the prices of the items in the cart over time start rising and rising consistently, there may be a bout of inflation. Most economies do accept a level of inflation of about 2% per annum.
Although the ONS puts the inflation figures together, it is the Bank of England – as the Central Bank of the UK - that ‘controls’ it.
Central Banks, like the Bank of England, are non-market and non-competitive banks, which have 3 distinct roles:
1) Regulating commercial banks, making sure they have solid balance-sheets; and
2) Acting as a last resort lender to banks and the government if necessary (like in the Great Crisis of 2008);
3) Controlling all the liquidity in the system and to avoid inflation, which is the reason why only the Central Banks can print money.
But how does a Central Bank ‘control’ inflation? Controlling inflation can be understood as the objective of the Central Banks to maintain stability, i.e to establish stable prices and a stable currency. Stable prices normally mean a stable economy and, most of the time, a predictable rate of employment.
If a Central Bank thinks we are not spending enough (we may rather save or invest our money instead), it may decide to increase liquidity by lowering interest rates, spurring us on to spend, not save, and to boost economic growth. The reverse is true too, if growth is strong and there is a lot of demand for goods and services, prices are expected to go up and the Bank will increase interest rates to put a break on spending.
About every 6 weeks the Central Bank governors meet to discuss all economic data and to decide what the level of interest rates should be and why. They can hold rates (which is what they mostly do), increase or decrease rates and the changes are usually not dramatic.