The government’s focus must be to bring inflation down
In the 12 months to April, inflation has risen from two to nine per cent, the highest increase on record, with further rises forecast by the Bank of England by the end of the year.
Increasing prices in the face of slower pay growth puts a huge strain on household budgets, with the least well-off hit hardest. The Institute for Fiscal Studies estimates the poorest 10 per cent of households face the highest inflation rate – up to 14 per cent – because they spend a high proportion of their money on energy and food.
Higher inflation also means households are likely to cut back on spending, and consumer confidence is falling to lows not seen since the 1970s. This has led the Bank of England to forecast a decline in economic growth next year, which in turn will place greater pressure on the public finances.
The Bank was just too slow to pick up on how persistent inflation had become, and far too ready to pursue a programme of quantitative easing
The Governor of the Bank of England recently told the Treasury Committee that, of all the causes of higher inflation, 80 per cent of the overshoot against the Bank’s inflation target is driven by price rises in energy and tradeable goods. The Bank suggests the other 20 per cent results from a tight labour market, in which there are now more jobs available than people looking for work.
Members of the Monetary Policy Committee have pointed out that the extent of energy and food price surges on the back of Vladimir Putin’s invasion of Ukraine were both difficult to predict and not themselves affected by tighter monetary policy. Monetary tightening takes time to take effect, and there is a risk it might only bite at the point the economy is already cooling and inflation has passed through.
Whilst these are perfectly fair points, many understandably feel the Bank was just too slow to pick up on how persistent inflation had become, and far too ready to pursue a programme of quantitative easing that pumped hundreds of billions into the economy, to the convenience of the government which was out in the capital markets aggressively raising debt. These factors will contribute to inflation staying higher for longer than would otherwise have been the case, albeit that any amount of monetary tightening would not have reigned in the spike in the price of oil and gas.
It is the so called “second round” effects in the labour market where the Bank faces the toughest questions. It was slow to grasp how quickly the labour market was heating up and initially focused too much on the emergence of hot spots, such as HGV drivers, without fully grasping how the heat was spilling over into the labour market more generally.
Now inflationary expectations are so substantially de-anchored from the two per cent target we appear to be in at least the foothills of a wage price spiral – with wages chasing prices and prices responding to increased wages in turn.
The consequences of any such sustained spiral will be incredibly damaging for the United Kingdom’s economy and make the strength of the monetary medicine required to tame inflation all the harsher. Monetary tightening means higher interest rates and the application of the brakes to an economy which is already slowing and possibly heading into recession.
Monetary policy is only part of the inflation story; the other is fiscal policy. And given current circumstances the Chancellor’s recent Commons statement, which channelled £15bn to households, should be carefully examined with inflation in mind. It will raise consumer demand quite rapidly given that those at the lowest end of the income distribution will have the highest propensity to spend. In general terms, I fully support the Chancellor’s actions. Exceptional times call for an exceptional response.
What that response will mean for inflation has now become one of the central questions. We look forward to the Chancellor appearing before the committee to address that question among many others.
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