Business

Sunday 4 December 2016

Dan O'Brien: Inflation is dead, but some prices are soaring

Published 11/09/2016 | 02:30

Prices of anything to do with health, from medicines to doctors' fees, have moderated since the crash. They nearly doubled in the eight years up to 2008. In the eight years since, healthcare inflation has risen by just under 10pc on average (Stock picture)
Prices of anything to do with health, from medicines to doctors' fees, have moderated since the crash. They nearly doubled in the eight years up to 2008. In the eight years since, healthcare inflation has risen by just under 10pc on average (Stock picture)

Last Thursday at 11am the latest inflation figures were published. At first glance they showed that inflation remains dead as a dodo. Prices fell slightly in August compared to July. They were the tiniest tad below the level in the same month last year.

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Just as those figures were published, Philip Lane, the head of Ireland's Central Bank, was in Frankfurt with his two dozen colleagues who sit on the governing council of the ECB. They were wrapping up their monthly interest rate setting meeting.

A couple of hours later, the top man in Frankfurt, Mario Draghi, gave his standard post-meeting press conference. Despite inflation being as dead across the entire Eurozone as it is in Ireland, the Italian did not appear to be under pressure for, yet again, missing his inflation target by a country mile.

In August, consumer prices in the Eurozone were 0.2pc higher than 12 months earlier. The mandate of the ECB is for a rate of inflation nine times that.

The bank has not met its mandated inflation target for more than three years. Indeed, since zone-wide inflation fell to 0.7pc in October 2013, it has not gone above 1pc, never mind moving towards the mandated 2pc.

We will return to central banking matters presently, but let's consider first what's going on with inflation in Ireland.

The consumer price level peaked in September 2008. Its near 10pc decline over the next 15 months was the biggest in living memory. Despite being gripped by recession in 2010 and 2011, inflation returned, albeit modestly.

Then in 2012, just as the recovery took hold, inflation died off. That, incidentally, is exactly not what one would expect - a rise in demand tends to push prices up. Things have changed little since. Prices overall have been as flat as a pancake, and the price level now remains around 2pc lower than eight years ago. That's worth repeating - the cost of living today is below what it was in late summer 2008.

But the basket of consumer prices contains many different products and services. There have been some quite remarkable differences in trends in recent years.

Among the most topical is motor insurance. It has been on a roller-coaster since figures were first compiled in 2003. In the four years to the crash, the cost of being insured on the road fell by a whopping 40pc. There were few calls in protest to RTE's Joe Duffy.

Then, as the recession took hold and - crucially - Quinn Insurance went into crisis, premiums started rising. Since the autumn of 2014, they are up 60pc. And there have been many calls to Joe.

Looking at transport insurance comparatively, we see how topsy turvy we are compared to the Steady Eddies in the rest of the euro area. Across the bloc as a whole, premium prices rose gradually before the crisis and have since stabilised, a very different pattern to the Irish one.

That a lot more has been made of motor insurance prices when they have been rising than when they have been falling is unsurprising. Psychologists have long established that we tend to take gains in our stride, but get peeved about a loss of the same size.

Among the most extreme recent cases of falling prices is clothing and footwear. Since the economy crashed, shoes, skirts and shirts have fallen by a massive one-third in price on average. They are half what they were at the turn of the century. It has never been cheaper to get togged out.

The most basic necessity of all - food and drink - is also a good bit cheaper. A basket of edibles now costs as much as it did 15 years ago. Since the crash, prices have been ground down as competition in the grocery sector has become fiercer. And they continue to fall.

Prices of anything to do with health, from medicines to doctors' fees, have moderated since the crash. They nearly doubled in the eight years up to 2008. In the eight years since, healthcare inflation has risen by just under 10pc on average.

But, as ever, averages can mask a lot, as our other chart shows. Hospital and dental services prices are still rising strongly, accounting for all of the increase in overall healthcare inflation. The belated government focus on ending the scandalous over-payment to pharmaceutical companies for medicines has yielded some gains, as the chart shows. That has helped drag overall healthcare inflation back a bit.

But if the cost of looking after body and soul has moderated, the same cannot be said for the nurturing of young minds. Education inflation continues to go through the roof. Prices of education services have risen 150pc since 2000. Nor have they shown much sign of slowing over the past eight years. In the past year alone, they are up almost 4pc.

Given the range of price changes across the entire economy, it is more than a little remarkable that they have managed to cancel each other out to give a historically very unusual zero inflation period. For Ireland, low inflation and the flirtation with deflation really doesn't matter much. As the economy is growing strongly, there is less chance of a deflationary cycle of awfulness taking hold than there is across much of the continent where activity is weak or in the doldrums.

But as we are in a monetary union, the currency zone's central bankers are mandated to look at overall conditions when formulating policy.

It is now 18 months since they launched their latest round of unconventional measures - in the current case, "quantitative easing". They recently passed the €1trn threshold in their purchases of financial assets, all designed to stimulate the economy and get inflation back to the level where it can grease the wheels of the economy.

Last Thursday Draghi did not rule out continuing the QE programme well into next year. Nor has he ruled out doing even more to try to meet his inflation mandate. Exactly what he could do remains an open question.

As it happens, Lane's predecessor, Patrick Honohan, was asking that very question last week. The ex-central banker, who has been busy writing papers since shedding the shackles of management, published a report* on how stimulus could be stepped up (co-authored with three others).

The four academic economists don't buy the argument that central bankers are running out of ammunition in the battle against deflation.

They say that there are still plenty of options available, including raising central banks' inflation targets. One can only wonder if the ex-governor made this case when he was sitting around the table in Frankfurt in the company of more than a few colleagues who tend to produce steam from their ears when they hear such proposals.

* http://voxeu.org/content/what-else-can-central-banks-do

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