Adjusting for economic inflation

Context

It is technically difficult to forecast inflation, particularly at a time of economic instability. In addition, explicit provision for inflation may be regarded as causing that very inflation. As a result, plans and budgets are often drawn up as at constant prices. Inflation can play havoc with such forecasts, especially if during accelerating inflation spending rises faster than revenue. This is will occur if, for example, taxes are not fully indexed to inflation while government wages and transfer payments are.

Implementation

Both developing and developed countries have to consider adjustments for inflation. An example is the British government, which shifted from from the use of constant prices to current prices in medium-term expenditure planning. Previously there had been a constant upward pressure on total spending as automatic adjustments were made to spending allocations in response to price movements. By contrast, the new system of "cash planning" imposed binding cash limits on departmental spending, thus allowing greater discipline in budgetary control.

Claim

Democracy equals inflation. (One of Parkinson's laws – by which Professor Parkinson meant that where the working population, through control of the electoral process, ultimately determines it conditions of employment, there will be more demand for high pay than for increased production).

For proper management of fiscal deficits, inflation must be taken explicitly into account in planning and budgeting. Although medium-term spending plans are generally drawn up in constant prices, they should consider the likely consequences of alternative inflation conditions. Again, although annual budgets are formulated in current terms, contingencies should be built in for unexpected price changes.