2. Consider Figure 2. Judge the UK's in ation history in an international context; can you think of reasons why the UK has performed as it has? Consider, and try to explain, the recent higher in ation levels in this historical context.

Figure 2: Plots of inflation calculated from Consumer Price Index data for all goods in the UK, US and
Japan. Source: OECD.

     Generally UK’s inflation levels follow patterns of other countries shown on the diagram (US and Japan). All three countries experienced high inflation during mid-70s (although it was less visible in the US and in 1980. However, the peaks were most extreme for the UK, while Japanese and American inflation levels fluctuated less.

     In 1975, due to futile Keynesian demand management attempts, inflation in the UK reached record highs (25%). This was caused by government policies aimed at pushing more demand. Ever since this time, defeating inflation has become a priority for governments, which had to abandon their previous goals of keeping unemployment low. In the aftermath of the 1981 budget, inflation fell for a couple of years.

     Recession in the early 1980s suggested that financial policy was too tight, yet inflation levels did not meet its targets. There were two main reasons for that, one being wage push inflation (trade unions refused to adjust wage behavior) and rising prices of oil (several OPEC countries lowered their production levels and artificially increased prices).

     The last peak was in year 1992. At this time UK has withdrawn from the Exchange Rate Mechanism (ERM), which allowed it to lower interest rates and target inflation more effectively. Since then inflation level in the UK remained quite low and under control until recently. The economic crisis pushed commodity prices up, resulting in inflation rate reaching almost 5% in summer 2011.