Sunday, 30 August 2009

Inflation – Every Little Helps

What can loyalty cards tell us about inflation?

When I was young my father made a big thing of collecting GreenShield stamps. For those around in the mid-70’s, you’ll remember that a number of participating retailers issued coupon books and then issued stamps when you purchased groceries or petrol. You had to stick 40 stamps on a page and when the book was full [1280 stamps], you could exchange it for tatty goods in the catalogue showrooms, that eventually became Argos. You could even redeem books for a speedboat (without outboard motor) by spending the equivalent of a new house on petrol, booze & fags.

I don’t think we ever did redeem the books but it was the 1970’s. And for a little boy, sticking the stamps in the book probably got me into the fantastically popular football sticker albums that came along shortly after. But that’s another story.

Green Shield Stamps weren’t the first incentive scheme and we’ve had a series of others since. Airmiles, Nectar and retailer’s own schemes. But what’s focusing my mind is they all seem to fade away after a while. And they all fade away when their value becomes debased, which tells us a little bit about the causes & effects of inflation, which I am convinced is round the corner.

The debasement normally follows a familiar pattern. The loyalty scheme builds-up a customer base. Then there’s a promotion that offers extra stamps/points for a given spend. And suddenly the stamps/points that have been accumulated can’t buy as much as they used to. Or, in a cynical twist, you can maintain the previous spending-power but only redeeming for stuff you wouldn’t want anyway. In any event, as ‘a store of value’ they’re not worth that much anymore. And then a new much larger denomination stamp comes along….

Now substitute the words "stamp" or “point” for “pound” and it all sounds a bit like inflation to me. Which is why I am perplexed by the decision by Tesco to give double points on their loyalty scheme and to publicise it so widely as a Good Thing this week.

The other day we had a mailing from Tesco in the bunnco household. We shop there occasionally and when we do it’s normally for a couple of hundred quid. The company proudly informed us that we had spent enough to qualify for a £3.50 voucher to spend on-the-house. Thanks Tesco!

I suppose that by sending the voucher, they’ve now redeemed and cancelled the old points so that in future new vouchers will effectively consist of ‘new’ double-points, rather like the Zimbabwean’s knocking a few zeros off the trillion-dollar banknotes. But you’re still only going to be able to get a free can of beans for every £100 you spend! We all know that… no matter how much you spend.

And you'll save more than you'll ever get in vouchers by shopping elsewhere, which is why Lidl, Aldi & new own-brand 'Value' ranges are now more popular.

But I suppose that Tesco’s decision is meant to make people feel richer even if the points produced aren’t worth as much as they used to be.

Which is why I think Tesco is making a big mistake whilst doing us all a favour: So many people participate in the Tesco scheme that they can now see for themselves in the comfort of their own homes how inflation happens when traditional stores of value are debased and what the consequences are. But with points, not pounds.

I’m not an economist but I do understand economics. And the parallels between the Bank of England’s Quantitative Easing [QE] policy and Tesco’s decision to print-points seem clear to me. There’ll be a lot more points/pounds in circulation which will make people feel richer but they won’t be able to buy as much as before because inflation will fill the gap. It’s what happens. And the extra £50bn QE splurge announced two weeks ago is going to make it worse.

So it means getting out of cash and into assets, which is why the estate agents suddenly don’t have a lot of houses to sell but at least the Tesco Loyalty Card manager can apply for the Nobel Prize for Economics for making it clear to everyone at a level they can understand how increasing the money supply excessively is the road to ruin.


runnymede said...

Bunnco - all very interesting but missing the important point. The money supply, properly measured, hasn't been exploding but has been stagnant or shrinking. If unchecked, that would have led to deflation and a protracted recession.

The purpose of QE is not to create some massive asset bubble but merely to restore normal rates of broad money growth, consistent with 2% inflation over the medium term. The amounts being done have been calibrated to that end.

As for the mechanism by which QE might work, you are on the right lines. The idea is indeed to create additional cash balances that will be spent on goods or assets. But that's not a bad thing, unless taken to excess - and there is no evidence that is being taken to excess, as I noted above.

Understanding the details of these issues is very important to avoid profound misunderstandings.

Anonymous said...

Thanks for an interesting article Buncco. I don't claim any great understanding of Economics but I recognise runnymede's argument and your own.

The point of QE appears to be to an attempt to avoid deflation but it's a potentially dangerous weapon with a significant risk of resulting in the opposite - inflation.

From a personal perspective, low interest rates suit me very well at present. So I hope we don't see inflation soon with presumably higher interest rates as a response to this.

Most commentators I have read suggest that interest rates will rise sharply before too long. By this I think they mean rising by 3-4 percent and starting to rise in 9-12 months or so.

I would be interested in others views on the likely paths for inflation and interest rates. Ken is good at this stuff. Not seen him on the site for a while.

Thanks for the article.

stjohn said...

Anonymous at 2 is me. stjohn

runnymede said...

StJohn - the current monetary policy strategy is indeed one that carries risks.

The main risk is of miscalibration resulting from mismeasurement/misinterpretation of monetary aggregates. In the early 1980s, monetary policy ended up being somewhat too tight as a result of errors of this kinds, compounding the recession.

But with output having dropped so steeply, creating a large volume of spare capacity in the economy, the risk of overdoing QE and quickly getting inflation is probably somewhat lower than the risk of doing too little.

It is also the case that what the Bank of England has done can quite quickly be reversed, if necessary. And a key difference from earlier periods is the Bank's independence, which removes the risk of policy being kept too loose for political reasons.

On interest rates, the path you set out is probably around the consensus expectation now. My own view is that rates are likely to rise relatively slowly from here, at a less rapid pace than you suggest.

Richard Nabavi said...

I hope runnymede is right, but I have a niggling doubt about the timing. The problem is (as we saw in the eighties) there is a gap of many months between putting measures in place to stimulate or rein back the economy, and the effect showing up. That makes calibrating any measures extremely difficult; the risk will always be that you end up overshooting.

runnymede said...

Richard - the danger of mistiming policy interventions is always there, whether they be standard monetary (i.e. interest rate changes), non-standard monetary (QE) or fiscal - all policies work with a lag and are vulnerable to errors in the data and of its interpretation.

But the alternative is simply to do nothing and allow booms and busts to run unchecked. For me the dangers of the latter are greater, and only a small minority of economists would disagree. Stabilisation policy is far from perfect but is the better option in an imperfect world.

You also seem to be implying that the risk of overdoing policy interventions is generally greater than that of doing too little. I'm not sure that position can be supported either theoretically or empirically. The obvious counterexample is of course the interwar period, which has been a heavy influence on policmakers' behaviour over the last 18 months.

stjohn said...

Thanks for that runnymede. Like Richard, I hope you are right!

Richard Nabavi said...

runnymede - Yes, I was implying that the risk of overshoot is bigger than the risk of undershoot, especially in present circumstances. I take your point about the interwar period, but policymakers are very conscious of that. On the other hand, the political pressure to 'do something', and if that doesn't produce rapid results to 'do some more', is obvious.

Maybe I'm underestimating the skill of the Bank of England and its equivalents around the world, but it looks a really tricky thing to get right. We won't really know for a couple of years whether they did get it right.

runnymede said...

Richard - aside from the different political situation compared to previous periods, i.e. the existence of independent central banks, there are sound technical reasons to think the dangers of doing too little are greater than of doing too much.

One way of thinking about it is that it is much harder for policy to push against the prevailing wind than to push with it. The biggest policy errors tend to involve waiting too long to tighten policy in booms and waiting too long before easing policy in slumps.

Errors of premature or excessive loosening do occur but are rarer because policymakers tend to wait until the evidence accumulates that they must act which time it is often too late.

Moreover, it is generally rather easier to correct excessive loosening than it is to try to 'catch up' by loosening more once it becomes clear not enough has done. In the latter cases, contractionary forces will have become so entrenched that policy will be much less effective.