Socialist Worker

What causes inflation?

by Anindya Bhattacharyya
Issue No. 2049

It's not often that a politician's actions can rally together millions of ordinary people from all walks of life. But that's what chancellor Gordon Brown has managed to do by imposing a maximum 2 percent wage rise across the public sector.

Civil service workers, teachers, health workers, postal workers and many more are all uniting to oppose Brown's pay freeze.

They know that inflation is running at 4.8 percent or more for ordinary people – and that Brown's freeze means a pay cut of at least 2.7 percent in real terms. And all this comes as mortgage and housing costs are set to rise further.

So why is Brown insisting on a wage freeze that is threatening to spark levels of industrial militancy not seen for years? Ironically, he says the freeze is necessary precisely because inflation is running so high.

The underlying argument is that inflation is primarily driven by wage increases. But even Mervyn King, the governor of the Bank of England, admits that this is not the case.

By law he is required to write an 'open letter' to the chancellor if inflation rates drift too far from the government's target, explaining what steps the bank will take to get back on track.

King's letter pinpoints rising prices, rather than rising wages, as the key factor driving inflation.


'Businesses have become more confident that they could raise prices to rebuild profit margins,' he writes. 'Official data for output prices and responses to business surveys confirm that the pricing climate in which businesses operate has become somewhat easier.'

King explicitly discounts wage rises as a factor behind inflation: 'Pay growth has, at least so far, failed to materialise. Although it is still too early to be confident, wage settlements are not far above last year's levels and in the public sector are modest.'

So even though it is bosses who are raising prices, Brown responds by slashing the pay of millions of workers. This is how neoliberalism works – nothing is allowed to interfere with their sacrosanct right to make profits.

In fact this ideology underlies the whole way that inflation is presented in the mainstream media, as well as the policies that governments deploy to manage it.

Inflation has been a systematic feature of Western economies since the Second World War. It is generally viewed as a 'bad thing' by bosses, though what they dislike is its unpredictability rather than inflation itself.

This is why Brown's economic policies are committed to an inflation target of 2 percent in the Consumer Price Index (CPI) – the government's preferred measure, which excludes housing costs and does not reflect people's real outgoings.

The Bank of England's Monetary Policy Committee, which Brown appoints and King heads, is charged with tweaking interest rates in order to maintain 'price stability'.

But how does inflation get into the economy in the first place?

The reasons for this all involve crucial features of the capitalist system – the fact that it is unplanned, and driven by competition for profits.


During a period of growth, bosses compete to invest where they think they can make a profit. Typically this involves different capitalists all trying to buy the same raw materials – thus driving up their price.

This price rise eats into their profits, so they respond by raising the prices of the commodities they produce. The effect is to pass the costs on to other capitalists, who in turn raise their prices, all the way down the chain to commodities bought by ordinary people.

Wage rises are a secondary effect of inflation. As inflation kicks in, workers start to notice that their pay packets do not stretch as far as they used to. This in turn leads them to demand pay rises from their employers.

Employers do not want to give their workers pay rises, but can be forced to do so through industrial action, or to head off a threat of industrial action. In certain circumstances, they may have to compete for scarce labour, which again raises wages.

A rising wage bill once more eats into profits, which can be yet another excuse for bosses to raise prices. But the overall reason for inflation is always the drive to keep profit rates up, not the 'greed' of workers trying to make ends meet in a climate of rising prices.

If the economy could be planned, then in theory these kinds of vicious circles could be ironed out. But that would involve the interests of businesses being subordinated to the interests of the people.

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Tue 1 May 2007, 19:22 BST
Issue No. 2049
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