Why do governments think they can control inflation?

Now that the UK has tentatively but officially crawled out of recession, thoughts turn to when interest rates will rise across the developed world.  Conventional wisdom states that sooner or later, excess capacity in an economy gets taken up as growth returns and eventually that leads to inflationary pressure.

The only problem is, I don’t agree with this analysis.  I’ve already said before and I will say again, inflation can no longer be controlled by governments.  Commodity prices worldwide are driven by global demand and with competition rife and supply chains tightly managed, products in store are a function of the raw material costs.  Similarly, if products in manufactured in a high growth economy like China where excess capacity has already been taken up, inflationary pressure there causes product prices to rise elsewhere.  And with our current erratic weather conditions, even food prices are affected by things beyond our control.

So I can’t help but laugh out loud when I see central bankers in the west increase interest rates to try to control inflation.  Like the banking industry, they can only be controlled by concerted global effort.  So inflation also needs coordinated global effort.

The role of government in a globalized world

I read with fascination as government’s across the world attempt to convince their citizens that they are somehow in control of inflation.  Right now, a return to growth has seen an increase in the price of commodities with the price of a barrel of oil nearly doubling since the beginning of the year.  Other commodities are also increasing with the Commodities Price Index increasing nearly 35% over the last twelve months.  These are numbers that no national governments can control.

Then add in the effects of a fundamental increase in the demand for food as population grows and income levels increase around the world and you have a a perfect recipe for serious increases in the price of basic food products.

As far as I can tell, the price of raw materials, oil and food pretty much determine inflation levels – none of which are controllable by governments in a globalized and competitive economy.  That is obviously not to say that inflation is going to run out of control over the next year or two.  Prices dropped so significantly in 2008 that it will take time for inflation to become a problem.

But I really think government should come clean.  Their ability to control the key levers of their economies are reducing by the day.