A toxic combination for economic policy
on April 3, 2015

UK economic policy is now coming under discussion, as May’s Gemeral Election approaches.  The Financial Times has kindly printed my letter below, highlighting the economic impact of the demographic changes now underway.

April 1, 2015 9:34 pm

Sir, Your editorial “Zero significance in the UK inflation milestone”, (March 27) ignores the impact of two critical variables. As a result, its conclusion misses the real importance of the UK’s move into deflation.

The first key variable is the collapse in fertility rates since the end of the postwar baby boom. These reduced from the 1960s peak of 2.8 babies/woman to just 1.7 babies/woman 40 years later. The second is the major increase in life expectancy over the same period. This has risen by almost two-thirds at age 65, to 23 years.

Consumption is around 60 per cent of gross domestic product. Thus the boomers created an economic supercycle as they moved into the 25-50 age group, when spending and incomes typically peak. But now the pendulum is swinging the other way. The ageing of the boomers means the majority of UK households have been headed by someone aged over 50 since 2002. These older households already own most of what they need, and their incomes are declining as they head into retirement. At the same time, lower fertility rates mean there are fewer households in the highest-spending 30-49 age group. Thus average household expenditure has been in steady decline since 2006 in real terms.

This is creating a paradigm shift of historic proportions. But instead of tackling the core issue, policy makers have chosen to use monetary policy to treat its symptoms, via the creation of temporary wealth effects in housing and financial markets. The end-result has been to build up further headwinds for future spending by younger households. These will now have to repay the debt created by quantitative easing and jumbo mortgages.

Contrary to your view, therefore, today’s zero inflation rate has enormous significance for the UK economy. Deflation, slowing growth and debt are likely to prove a toxic combination for economic policy after May’s general election.

Paul Hodges
Chairman, International eChem

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