Demonising Inflation & the True Cost of Living
Anthony Yates looks at Rishi Sunak’s promises over inflation which might help him cynically suppress public pay demands but do nothing to address the roots of our economic malaise
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UK inflation is falling; down from 10.4% in the 12 months to February, to 10.1% in March. The Bank of England expects it to fall rapidly this year, but there is a lot of uncertainty about how much more of a helping hand this process will need from monetary policy [interest rates], and how much the fact of past energy price rises not repeating themselves will do the job.
A surge this big is not unprecedented in UK history – it reached into the 20s in the 1970s – but it is unprecedented in the time since the Bank of England was given the responsibility to hit an inflation target [set at 2% currently].
Back in January, Rishi Sunak attempted a re-launch of the government with a set of 5 ‘people’s priorities’ including the commitment to ‘halve inflation’ over the year. This promise may well yet be met. It sounds like a reasonable enough goal but deploys a fair amount of cynicism in that it feeds off the considerable confusion that exists concerning what is causing our current economic problems and what we should do about them.
One of the reasons the promise was on the list is to manufacture a reason to hold out against the pay demands of striking public sector workers. Sunak and others in government have often given the reason that such pay increases can’t be conceded as that they would be inflationary.
The real reason those settlements are being resisted is that Sunak is reluctant to commit to funding them with the necessary taxes, which much of his party object to on ideological grounds, and which would make a pre-2024 tax bribe difficult or impossible.
A properly tax-funded increase in public sector pay to address recruitment and retention need not be inflationary. Even if it were funded by borrowing for a while [I would not recommend this] the Bank of England could respond with tighter monetary policy anyway.
It is therefore a myth that Sunak needs to restrain public sector pay to combat inflation. Public sector pay needs to be worked out by first asking what level of public service provision we want, and then paying appropriately to recruit and retain staff. Sunak’s government doesn’t want to ask that question. Partly for ideological reasons, and partly because it is wedded to the delusion that shrinking the state from this point will stimulate growth/ It wants low taxes, and wants to blame poor services on unpatriotic and complaining public sector workers. If it is too open about the quality of services implied by low taxes, it worries that voters, who are very concerned about the state of the NHS, for example, will desert them at the polls.
A second reason the inflation focus of the government is unhelpful is that it plays on the idea that inflation itself is the problem. If only we could ‘halve’ it, [roughly to 5%], and then lower it back to the 2% target, the cost of living crisis would be over.
In fact, lowering inflation back to 2% would not reverse the price increases we have seen so far. It would merely mean they rise at 2% from that point.
The True Cost of Living
More importantly still, inflation is itself not the fundamental problem we are going through. On the contrary, it is the policy solution we chose out of a set of poor options. The root cause of our difficulties is the combination of factors lowering our cost of living, meant literally: how much effort we have to put in to produce the things we need and want to live.
There are many of these. The most important currently is probably the increase in energy prices caused by Putin’s invasion of Ukraine. Also crucial is the slow accretion of costs caused by Brexit which has impacted on UK food prices and led to more vulnerability in supply chains of products vulnerable to extreme weather, and impeded trade more generally. Third is the impact of covid and now geopolitics on global supply chains of food and manufactured goods.
All these things impoverish us on average. We can make choices with fiscal policy to shield some from some or all of their effects, but on average we cannot avoid them and someone has to bear their cost. We could have embarked on this unpleasant decline with inflation much close to target, but only by raising interest rates sharply, and causing a big recession, which would be needed to reduce demand. This would have kept inflation closer to target, and the fall in real standards of living would have been produced by sharply falling nominal wages.
This would have been a far worse policy choice because it would most lkely also have meant a big increase in unemployment. We would have generated roughly the same drop in the average standard of living, but this would be shared out much more unequally with those having lost their jobs suffering the most.
We are also learning that highly vigorous use of interest rates like this can put banks into difficulty, as we saw with the failure of Silicon Valley and Signature Banks, and also Credit Suisse. Exactly how much/whether we are going to need to reduce the aggressiveness of interest rate policy in the future is yet to be worked out.
So inflation is the unpleasant symptom of our economic malaise. But most of the unpleasantness is because prices were rising faster than wages. It is not the real cause of our problems but rather the best response to them.
The Price of a Pint of Milk
Another reason Sunak’s inflation promise was cynical was that he was attempting to take credit for something that the Bank of England was already forecasting would happen, and which was its main job. Since 1997 when the Bank of England was made independent, inflation control has been delegated to it. That means deciding how much to allow inflation to wander from target if there is a large shock like what we have just gone through, and how quickly to bring it back again.
Earlier in the month the think tank MoreinCommon ran a survey, whose results were previewed by Robert Peston on Twitter, asking people what they think would happen to the price of a ‘£1 pint of milk’ if Sunak fulfilled his promise. The framing was meant to imply that the correct answer was £1.05 – 5% more than £1. Only 34% of respondents chose this answer.
The commentariat interpreted this as evidence that it was a bad promise as people would not grasp the implications of Sunak having succeeded. Actually, the question did not show what some of the commentators intended. The correct answer really is ‘don’t know’ which 17% of people responding chose.
This is correct because it’s not possible to know the price of a pint of milk in 12 months without knowing what will happen to the milk market. Typically goods prices rise less than average inflation. Recently food price inflation has been much higher. The question supposes a ‘£1 pint of milk’ but many don’t buy in pints, or may have bought one recently for more or less than £1 and find the question confusing.
Another reading of this survey is that not only are people confused by inflation but survey designers and journalists also find it difficult!
There are two other possible lessons to draw from this exercise. First, a promise that is not easily understood can be a useful weapon. In this case to stiffen support for government resistance to public sector pay disputes, or harvest credit for something where it is not due. Second, economics is hard and there are more pervasive misunderstandings about it afflicting not just the public but also writers in the media. A misunderstanding in which poor economic policy debate can prosper.
The four biggest economic policy mistakes of recent times are, in chronological order, probably: the financial crisis of 2008, austerity in the early 2010s, Brexit and COVID policy [late and therefore long and tight lockdowns]. In all these cases, the economic debates are difficult and had protagonists on either side. This created more ambiguity than was justified about what the right policies were [respectively: tighter regulation, looser fiscal policy, Remain, earlier and shorter and looser lockdowns]. Into this noise, successive administrations were able to present policies that were wrong and ideological as necessary and pragmatic.
Sunak’s inflation promise itself is a much smaller deal than these errors, but it is contributing to a protracted policy failure of the same magnitude – the characterisation of just and economically beneficial public service provision as unaffordable and inconsistent with macroeconomic policy.