Tag: supply-chain issues

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Why raise interest rates to tackle cost-push inflation?

We have examined inflation in several blogs in recent months. With inflation at levels not seen for 40 years, this is hardly surprising. One question we’ve examined is whether the policy response has been correct. For example, in July, we asked whether the Bank of England had raised interest rates too much, too late. In judging policy, one useful distinction is between demand-pull inflation and cost-push inflation. Do they require the same policy response? Is raising interest rates to get inflation down to the target rate equally applicable to inflation caused by excessive demand and inflation caused by rising costs, where those rising costs are not caused by rising demand?

In terms of aggregate demand and supply, demand-pull inflation is shown by continuing rightward shifts in aggregate demand (AD); cost-push inflation is shown by continuing leftward/upward shifts in short-run aggregate supply (SRAS). This is illustrated in the following diagram, which shows a single shift in aggregate demand or short-run aggregate supply. For inflation to continue, rather than being a single rise in prices, the curves must continue to shift.

As you can see, the effects on real GDP (Y) are quite different. A rise in aggregate demand will tend to increase GDP (as long as capacity constraints allow). A rise in costs, and hence an upward shift in short-run aggregate supply, will lead to a fall in GDP as firms cut output in the face of rising costs and as consumers consume less as the cost of living rises.

The inflation experienced by the UK and other countries in recent months has been largely of the cost-push variety. Causes include: supply-chain bottlenecks as economies opened up after COVID-19; the war in Ukraine and its effects on oil and gas supplies and various grains; and avian flu and poor harvests from droughts and floods associated with global warming resulting in a fall in food supplies. These all led to a rise in prices. In the UK’s case, this was compounded by Brexit, which added to firms’ administrative costs and, according to the Bank of England, was estimated to cause a long-term fall in productivity of around 3 to 4 per cent.

The rise in costs had the effect of shifting short-run aggregate supply upwards to the left. As well as leading to a rise in prices and a cost-of-living squeeze, the rising costs dampened expenditure.

This was compounded by a tightening of fiscal policy as governments attempted to tackle public-sector deficits and debt, which had soared with the support measures during the pandemic. It was also compounded by rising interest rates as central banks attempted to bring inflation back to target.

Monetary policy response

Central banks are generally charged with keeping inflation in the medium term at a target rate set by the government or the central bank itself. For most developed countries, this is 2% (see table in the blog, Should central bank targets be changed?). So is raising interest rates the correct policy response to cost-push inflation?

One argument is that monetary policy is inappropriate in the face of supply shocks. The supply shocks themselves have the effect of dampening demand. Raising interest rates will compound this effect, resulting in lower growth or even a recession. If the supply shocks are temporary, such as supply-chain disruptions caused by lockdowns during the pandemic, then it might be better to ride out the problem and not raise interest rates or raise them by only a small amount. Already cost pressures are easing in some areas as supplies have risen.

If, however, the fall in aggregate supply is more persistent, such as from climate-related declines in harvests or the Ukraine war dragging on, or new disruptions to supply associated with the Israel–Gaza war, or, in the UK’s case, with Brexit, then real aggregate demand may need to be reduced in order to match the lower aggregate supply. Or, at the very least, the growth in aggregate demand may need to be slowed to match the slower growth in aggregate supply.

Huw Pill, the Chief Economist at the Bank of England, in a podcast from the Columbia Law School (see links below), argued that people should recognise that the rise in costs has made them poorer. If they respond to the rising costs by seeking higher wages, or in the case of businesses, by putting up prices, this will simply stoke inflation. In these circumstances, raising interest rates to cool aggregate demand may reduce people’s ability to gain higher wages or put up prices.

Another argument for raising interest rates in the face of cost-push inflation is when those cost increases are felt more than in other countries. The USA has suffered less from cost pressures than the UK. On the other hand, its growth rate is higher, suggesting that its inflation, albeit lower than in the UK, is more of the demand-pull variety. Despite its inflation rate being lower than in the UK, the problem of excess demand has led the Fed to adopt an aggressive interest rate policy. Its target rate is 5.25% to 5.50%, while the Bank of England’s is 5.25%. In order to prevent short-term capital outflows and a resulting depreciation in the pound, further stoking inflation, the Bank of England has been under pressure to mirror interest rate rises in the USA, the eurozone and elsewhere.

Articles

Blogs on this site

Information and data

Questions

  1. How may monetary policy affect inflationary expectations?
  2. If cost-push inflation makes people generally poorer, what role does the government have in making the distribution of a cut in real income a fair one?
  3. In the context of cost-push inflation, how might the authorities prevent a wage–price spiral?
  4. With reference to the second article above, explain the ‘monetary policy conundrum’ faced by the Bank of Japan.
  5. If central banks have a single policy instrument, namely changes in interest rates, how may conflicts arise when there is more than one macroeconomic objective?
  6. Is Russia’s rise in inflation the result of cost or demand pressures, or a mixture of the two (see articles above)?
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The costs of Brexit: a clearer picture

At the time of the 2016 referendum, the clear consensus among economists was that Brexit would impose net economic costs on the UK economy. The size of these costs would depend on the nature of post-Brexit trading relations with the EU. The fewer the new barriers to trade and the closer the alignment with the EU single market, the lower these costs would be.

The Brexit deal in the form of the EU-UK Trade and Cooperation Agreement (see also) applied provisionally from January 2021, after the end of the transition period, and came into force in May 2021. Although this is a free-trade deal in the sense that goods made largely in the UK or EU can be traded tariff-free between the two, the deal does not apply to services (e.g. financial services) or to goods where components made outside the UK or EU account for more than a certain percentage (the ‘rules of origin‘ condition). Also there has been a huge increase in documentation that must be completed to export to or import from the EU.

Even though the nature of the Brexit deal has been clear since it was signed in December 2020, assessing the impact of the extra barriers to trade it has created has been hard given the various shocks that have had a severe impact on the UK (and global) economy. First COVID-19 and the associated lockdowns had a direct effect on output and trade; second the longer-term international supply-chain disruptions have extended the COVID costs beyond the initial lockdowns and acted as a brake on recovery and growth; third the Russian invasion of Ukraine imposed a severe shock to energy and food markets; fourth these factors have created not just a supply shock but also an inflationary shock, which has resulted in central banks seeking to dampen demand by significantly raising interest rates. One worry among analysts was that the negative effects of such shocks might be greater on the UK economy than on other countries.

However, the negative effects of Brexit are now becoming clearer and various institutions have attempted to quantify the costs. These costs are largely in terms of lower GDP than otherwise. This results from:

  • reduced levels of trade with the EU, thereby reducing the gains from exploiting comparative advantage;
  • increased costs of trade with the EU;
  • disruptions to supply chains;
  • reduced competition from European firms, with many no longer exporting to the UK because of the costs;
  • reduced inward investment;
  • labour market shortages, particularly in certain areas such a hospitality, construction, social care and agriculture as many European workers have left the UK and fewer come;
  • a reduction in productivity.

Here is a summary of the findings of different organisations.

The Office for Budget Responsibility (OBR)

The OBR has argued that Brexit as negotiated in the Trade and Cooperation Agreement:

will reduce long-run productivity by 4 per cent relative to remaining in the EU. This largely reflects our view that the increase in non-tariff barriers on UK-EU trade acts as an additional impediment to the exploitation of comparative advantage.21

In addition the OBR estimates that:

Both exports and imports will be around 15 per cent lower in the long run than if the UK had remained in the EU.21

Recent evidence supports this. According to the OBR:

UK and aggregate advanced economy goods export volumes fell by around 20 per cent during the initial wave of the pandemic in 2020. But by the fourth quarter of 2021 total advanced economy trade volumes had rebounded to 3 per cent above their pre-pandemic levels while UK exports remain around 12 per cent below.22

This assumption was repeated in the November 2022 Economic and Fiscal Outlook (p.26) 23. What is more, new trade deals will make little difference, either because they are a roll-over from previous EU trade deals with the respective country or have only a very small effect (e.g. the trade deal with Australia).

The Bank of England

The Bank of England, ever since the referendum in 2016, has forecast that Brexit would damage trade, productivity and GDP growth. In recent evidence to the House of Commons Treasury Committee5, Andrew Bailey, the Governor, stated that previous work by the Bank concluded that Brexit would reduce productivity by a bit over 3% and that this was still the Bank’s view.

His colleague, Dr Swati Dhingra, stated that, because of Brexit, there was a ‘much bigger slowdown in trade in the UK compared to the rest of the world’. She continued:

The simple way of thinking about what Brexit has done to the economy is that in the period after the referendum, the biggest depreciation that any of the world’s four major economies have seen overnight contributed to increasing prices [and] reduced wages. …We think that number is about 2.6% below the trend that real wages would have been on. Soon afterwards and before the TCA happened came the effects of the uncertainty that was unleashed, which basically translates into reduced business investment and less certainty of the FDI effects. Those tend to be very long-pay things.

She continued that now we are seeing significantly reduced trade directly as a result of the Brexit trade agreement (TCA).

Her colleague, Dr Catherine Mann, argued that ‘the small firms are the ones that are the most damaged, because the cost of the paperwork and so forth is a barrier’. This does not only affect UK firms exporting to the EU but also EU firms exporting to the UK. Reduced imports from EU firms reduces competition in the UK, which tends to lead to higher prices.

The Institute for Fiscal Studies

The IFS has consistently argued that Brexit, because of increased trade barriers with the EU, has reduced UK trade, productivity and GDP. In a recent interview6, its Director, Paul Johnson, stated that ‘Brexit, without doubt, has made us poorer than we would otherwise have been’. That, plus other convulsions, such as the mini-Budget of October 2022, have reduced foreigners’ confidence in the UK, with the result that investment in the UK and trade with the rest of the world have fallen.

Resolution Foundation

In a major Resolution Foundation report24, the authors argued that the effects of Brexit will take time to materialise fully and will occur in three distinct phases. First, in anticipation of permanent effects, the referendum caused sterling to depreciate and this adversely affected household incomes. What is more, the uncertainty about the future caused business investment to fall (but not inward FDI). Second, the Trade and Cooperation Act, by introducing trade barriers, reduced UK trade with the EU. But trade with the rest of the world also fell suggesting that Brexit is impacting UK trade openness and competitiveness more broadly. Third, there will be structural changes to the UK economy over the long-term which will adversely affect economic growth:

A less-open UK will mean a poorer and less productive one by the end of the decade, with real wages expected to fall by 1.8 per cent, a loss of £470 per worker a year, and labour productivity by 1.3 per cent, as a result of the long-run changes to trade under the TCA. This would be equivalent to losing more than a quarter of the last decade’s productivity growth.

Nuffield Trust

One of the key effects of Brexit has been on the labour market and especially on sectors, such as hospitality, agriculture, construction, health and social care. These sectors are experiencing labour shortages, in part due to EU nationals leaving the UK. In 2021, the Nuffield Trust looked at the supply of workers in health and social care25 and found that, as a result of increased bureaucratic hurdles, the number of EU/EFTA-trained nurses had declined since 2016. In social care, new immigration rules have made it virtually impossible to recruit from the EU. A more recent report looked at the recruitment of doctors in four specific specialties.26 In each case, although the number recruited from the EU/EFTA was still increasing, the rate of increase had slowed significantly. The reason appeared to be Brexit not COVID-19.

Ivalua

Research by Coleman Parkes for Ivalua18 shows that 80% of firms found Brexit to have been the biggest cause of supply-chain disruptions in the 12 months to August 2022, with 83% fearing the biggest disruptions from Brexit are yet to come. Brexit was found to have had a bigger effect on supply chains than the war in Ukraine, rising energy costs and COVID-19.

Centre for European Reform

Modelling conducted by John Springford27 used a ‘doppelgängers’ method to show the effects of Brexit on the UK economy. Each doppelgänger is ‘a basket of countries whose economic performance closely matches the UK’s before the Brexit referendum and the end of the transition period’. Comparing the UK’s performance with the doppelgänger can show the difference between leaving and not leaving the UK. Doppelgängers were estimated for GDP, investment (gross fixed capital formation), total services trade (exports plus imports) and total goods trade (ditto).

The results are sobering. In the final quarter of 2021, UK GDP is 5.2 per cent smaller than the modelled, doppelgänger UK; investment is 13.7 per cent lower; and goods trade, 13.6 per cent lower.

Economic and Social Research Institute (ESRI) (Ireland)

Similar results for UK trade have been obtained by Janez Kren and Martina Lawless in research conducted for the ESRI.28 They used product-level trade flows between the EU and all other countries in the world as a comparison group. This showed a 16% reduction in UK exports to the EU and a 20% reduction in UK imports from the EU relative to the scenario in which Brexit had not occurred.

British Chambers of Commerce (BCC) survey

According to a BCC survey of 1168 businesses33, 92% of which are SMEs, more than three quarters (77%) for which the Brexit deal is applicable say it is not helping them increase sales or grow their business and 56% say they have difficulties in adapting to the new rules for trading goods. The survey shows that UK firms are facing significant challenges in trying to trade with EU countries under the terms of the Trade and Cooperation Agreement. What is more, 80% of firms had seen the cost of importing increase; 53% had seen their sales margins decrease; and almost 70% of manufacturers had experienced shortages of goods and services from the EU.

Academic studies

Research at the Centre for Business Prosperity, Aston University, by Jun Du, Emine Beyza Satoglu and Oleksandr Shepotylo20, 29 found that UK exports to the EU ‘fell by an average of 22.9% in the first 15 months after the introduction of the EU-UK Trade and Cooperation Agreement’. The negative effect on UK exports persisted and deepened from January 2021 to March 2022. The research involved comparing actual trade with an ‘alternative UK economy’ model based on the UK having remained in the EU. What is more, the researchers found that there had been a reduction of 42% in the number of product varieties exported to the EU, with a large number of exporters simply ceasing to export to the EU and with many of the remaining exporters streamlining their product ranges.

Research at the LSE’s Centre for Economic Performance by Jan David Bakker, Nikhil Datta, Richard Davies and Josh De Lyon31 found that leaving the EU added an average of £210 to UK household food bills over the two years to the end of 2021. This amounted to a total cost to consumers of £5.8 billion. This confirmed the findings of previous research30 that the increase in UK-EU trade barriers led to food prices in the UK being 6% higher than they would have been.

Finally, a report from the Migration Observatory at the University of Oxford32 examined the effects of the ending of the free movement of labour from the EU to the UK. Visas are now required, but ‘low-wage occupations that used to rely heavily on EU workers are now ineligible for work visas, with some limited exceptions for social care and seasonal workers’. Many industries are facing labour shortages. Reasons include other factors, such as low pay and unattractive working conditions, and workers leaving the workforce during the pandemic and afterwards. But the end of free movement appears to have exacerbated these existing problems.

References

    Videos

  1. The Brexit effect: how leaving the EU hit the UK

    2. Financial Times film (18/10/22)

  2. What impact is Brexit having on the UK economy?

    3. Brexit and the UK economy, Ros Atkins (29/10/22)

  3. Why Brexit is damaging the UK economy both now and in the future

    4. Economics Help on YouTube, Tejvan Pettinger (5/12/22)

  4. Why the Costs of Brexit keep growing for the UK economy

    5. Economics Help on YouTube, Tejvan Pettinger (17/10/22)

  5. Treasury Committee (see also)

    6. Parliament TV (25/11/22) (see 15:03:00 to 15:08:12) (Click here for a transcript: see Q637 to Q641)

  6. UK economy made worse by ‘own goals’ like Brexit and Truss mini-budget, IFS economist says

    7. Sky News, Paul Johnson (IFS) (18/11/22)

    Articles

  7. Brexit and the economy: the hit has been ‘substantially negative’

    8. Financial Times, Chris Giles (30/11/22)

  8. ‘What have we done?’: six years on, UK counts the cost of Brexit

    9. The Observer, Toby Helm, Robin McKie, James Tapper & Phillip Inman (25/6/22)

  9. Brexit did hurt the City’s exports – the numbers don’t lie

    10. Financial News, David Wighton (9/11/22)

  10. Brits are starting to think again about Brexit as the economy slides into recession

    11. CNBC, Elliot Smith (23/11/22)

  11. Brexit has cracked Britain’s economic foundations

    12. CNN, Hanna Ziady (24/12/22)

  12. Mark Carney: ‘Doubling down on inequality was a surprising choice’

    13. Financial Times, Edward Luce (14/10/22)

  13. Brexit: Progress on trade deals slower than promised

    14. BBC News, Ione Wells & Brian Wheeler (2/12/22)

  14. How Brexit costs this retailer £1m a month in sales

    15. BusinessLive, Tom Pegden (22/11/22)

  15. Brexit Is Hurting The UK Economy, Bank Of England Official Says

    16. HuffPost, Graeme Demianyk (16/11/22)

  16. Brexit and drop in workforce harming economic recovery, says Bank governor

    17. The Guardian, Richard Partington (16/11/22)

  17. Brexit a major cause of UK’s return to austerity, says senior economist

    18. The Guardian, Anna Isaac (14/11/22)

  18. 80% of UK businesses say Brexit caused the biggest supply chain disruption in the last 12 months

    19. Ivalua (28/11/22)

  19. Brexit added £210 to household food bills, new research finds

    20. Sky News, Faye Brown (1/12/22)

  20. Brexit changes caused 22.9% slump in UK-EU exports into Q1 2022 – research

    21. Expertfile (8/12/22)

    Research and analysis

  21. Brexit analysis

    22. OBR (26/5/22)

  22. The latest evidence on the impact of Brexit on UK trade

    23. OBR (March 2022)

  23. Economic and fiscal outlook – November 2022 (PDF)

    24. OBR (17/11/22)

  24. The Big Brexit (PDF)

    25. Resolution Foundation, Swati Dhingra, Emily Fry, Sophie Hale & Ningyuan Jia (June 2022)

  25. Going it alone: health and Brexit in the UK

    26. Nuffield Trust, Mark Dayan, Martha McCarey, Tamara Hervey, Nick Fahy, Scott L Greer, Holly Jarman, Ellen Stewart and Dan Bristow (20/12/21)

  26. Has Brexit affected the UK’s medical workforce?

    27. Nuffield Trust, Martha McCarey and Mark Dayan (27/11/22)

  27. What can we know about the cost of Brexit so far?

    28. Centre for European Reform, John Springford (9/6/22)

  28. Brexit reduced overall EU-UK goods trade flows by almost one-fifth

    29. Economic and Social Research Institute (Ireland), Janez Kren and Martina Lawless (19/10/22)

  29. Post-Brexit UK Trade – An Update (PDF)

    30. Centre for Business Prosperity, Aston University, Jun Du, Emine Beyza Satoglu and Oleksandr Shepotylo (November 2022)

  30. Post-Brexit imports, supply chains, and the effect on consumer prices (PDF)

    31. UK in a Changing Europe, Jan David Bakker, Nikhil Datta, Josh De Lyon, Luisa Opitz and Dilan Yang (25/4/22)

  31. Non-tariff barriers and consumer prices: evidence from Brexit

    32. Centre for Economic Performance, LSE, Jan David Bakker, Nikhil Datta, Richard Davies and Josh De Lyon (December 2022)

  32. How is the End of Free Movement Affecting the Low-wage Labour Force in the UK?

    33. Migration Observatory, University of Oxford, Madeleine Sumption, Chris Forde, Gabriella Alberti and Peter William Walsh (15/8/22)

  33. The Trade and Cooperation Agreement: Two Years On – Proposals For Reform by UK Business

    34. British Chambers of Commerce (21/12/22)

  34. The Detriments of Brexit

    35. Yorkshire Bylines (June 2022) (see also)

Questions

  1. Summarise the negative effects of Brexit on the UK economy.
  2. Why is it difficult to quantify these effects?
  3. Explain the ‘doppelgängers’ method of estimating the costs of Brexit? How reliable is this method likely to be?
  4. How have UK firms attempted to reduce the costs of exporting to the EU?
  5. Is Brexit the sole cause of a shortage of labour in many sectors in the UK?
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Rise in the cost of living
Part 1: What are the distributional consequences?

Households are expected to see further rises in the cost of living after the annual inflation rate climbed for a 13th month to its highest point in almost 30 years. This will put further pressure on already stretched household budgets. The increase reflects a bounceback in demand for goods and services after lockdowns, when prices fell sharply. It also reflects the impact of supply-chain disruptions as Covid-19 hit factory production and global trade.

The biggest concern, however, is the impact it will have on those already hard-pressed families across the UK. According to official figures, prices are rising at similar rates for richer and poorer households. However, household income levels will determine personal experiences of inflation. Poorer households find it harder to cope than richer families as essentials, such as energy and food, form a larger proportion of their shopping basket than discretionary items. On average the lowest-income families spend twice as much proportionately on food and housing bills as the richest. So low-income households, if they are already spending mainly on essentials, will struggle to find where to cut back as prices rise.

Latest Inflation figures

Latest figures from the ONS show that the Consumer Prices Index (CPI) rose by 5.5% in the year to January 2022, with further increases in the rate expected over the next couple of months. In measuring inflation, the ONS takes a so-called ‘basket of goods, which is frequently updated to reflect changes in spending patterns. For example, in 2021, hand sanitiser and men’s loungewear bottoms were added, but sandwiches bought at work were removed.

Annual CPI inflation is announced each month, showing how much the weighted average of these prices has risen since the same date last year. The weighted average is expressed as an index, with the index set at 100 in the base year, which is currently 2015.

Consumers would not normally notice price rises from month to month. However, prices are now rising so quickly that it is clear for everyone to see. What is more, average pay is not keeping up. There are workers in a few sectors, such as lorry drivers, who are in high demand, and therefore their wages are rising faster than prices. But the majority of workers won’t see such increases in pay. In the 12 months to January, prices rose by 5.5% on average, but regular pay, excluding bonuses, on average rose by only 4.7%, meaning that they fell by 0.8% in real terms.

The Bank of England has warned that CPI inflation could rise to 7% this year and some economists are forecasting that it could be almost 8% in April.

Why are costs rising?

From the weekly food shop, to filling up cars, to heating our homes, the cost of living is rising sharply around the world. Global inflation is at its highest since 2008. Some of the reasons why include:

  • Rising energy and petrol prices
    Oil prices slumped at the start of the pandemic, but demand has rocketed back since, and oil prices have hit a seven-year high. The price of gas has also shot up, leaving people around the world with eye-watering central heating bills. Home energy bills in the UK are set to rise by 54% in April when Ofgem, the energy regulator, raises the price cap.
  • Goods shortages
    During the pandemic, prices of everyday consumer goods increased. Consumers spent more on household goods and home improvements because they were stuck at home, couldn’t go out to eat or go on holiday. Manufacturers in places such as Asia have struggled to keep up with the demand. This has led to shortages of materials such as plastic, concrete and steel, driving up prices. Timber cost as much as 80% more than usual in 2021 in the UK.
  • Shipping costs
    Global shipping companies have been overwhelmed by surging demand after the pandemic and have responded by raising shipping charges. Retailers are now having to pay a lot more to get goods into stores. These prices are now being passed on to consumers. Air freight fees have also increased, having been made worse by a lorry driver shortage in Europe.
  • Rising wages
    During the pandemic many people changed jobs, or even quit the workforce – a problem exacerbated in the UK by Brexit as many European workers returned to their home countries. Firms are now having problems recruiting staff such as drivers, food processors and restaurant waiters. This has resulted in companies putting up wages to attract and retain staff. Those extra costs to employers are again being passed on to consumers.
  • Extreme weather impact
    Extreme weather in many parts of the world has contributed to inflation. Global oil supplies took a hit from hurricanes which damaged US oil infrastructure. Fierce storms in Texas also worsened the problems in meeting the demand for microchips. The cost of coffee has also jumped after Brazil had a poor harvest following its most severe drought in almost a century.
  • Trade barriers
    More costly imports are also contributing to higher prices. New post-Brexit trading rules are estimated to have reduced imports from the EU to the UK by about a quarter in the first half of 2021. In the USA, import tariffs on Chinese goods have almost entirely been passed on to US customers in the form of higher prices. Chinese telecoms giant Huawei said last year that sanctions imposed on the company by the USA in 2019 were affecting US suppliers and global customers.
  • The end of pandemic support
    Governments are ending the support given to businesses during the pandemic. Public spending and borrowing increased across the world leading to tax rises. This has contributed to rises in the cost-of-living, while most people’s wages have lagged behind.

Main concerns for the UK inflation

With rapidly rising prices, the economic decisions people will have to make are much harder. The main concerns for UK households include increases in energy costs, food prices, rent and interest rates on borrowing. All of these concerns come at a time when the government prepares to increase national insurance contributions for workers in April. There has been some pressure from MPs to scrap the tax rise so as to ease the pressure on living costs. It can be argued that there are fairer ways to increase taxes than through national insurance. However, the plan is relatively progressive, and scrapping the rise could be a badly targeted way of helping the poorest households with their energy bills.

Energy Bills
Electricity and gas bills for a typical household are expected to increase on average by £693 a year in April, which, as we have seen, is a 54% increase. Around 18 million households on standard tariffs will see an average increase from £1277 to £1971 per year. And around 4.5 million prepayment customers will see an average increase of £708 – from £1309 to £2017. Energy bills won’t rise immediately for customers on fixed rates, but many are likely to see a significant increase when their deal ends.

Bills are going up because the energy price cap is being raised. The energy price cap is an example of a maximum price being imposed on the market; it is the maximum price suppliers in England, Wales and Scotland can charge households for their energy. Energy firms can increase bills by 54% when the new cap is introduced in April. The price cap is currently reviewed every 6 months and it is expected that that prices will rise again in October.

Energy price rises are likely to hit Britain’s poorest households the hardest as they spend proportionately more of their income on energy, a problem exacerbated by many living in poorly insulated homes. More people are thus expected to find themselves facing fuel poverty. This means that they spend a disproportionate amount of their income on energy and cannot afford to heat their homes adequately. According to the Resolution Foundation, the poorest will see their energy spend rise from 8.5% to 12% of their total household budget, three times the percentage for the richest.

The way fuel poverty is measured varies around the UK. In Scotland, a household is in fuel poverty if more than 10% of its income is spent on fuel and its remaining income isn’t enough to maintain an adequate standard of living. It is expected that the number of homes facing ‘fuel stress’ across the UK will treble to 6.3 million after April. It will, however, have the greatest impact on pensioners, people in local authority housing and low-income single-adult households who on average could be forced to spend over 50% of their income on gas and electricity. The Resolution Foundation thinktank has warned that UK households are facing a ‘cost of living catastrophe’.

Food
Low-income households also spend a larger proportion than average on food and will therefore be relatively more affected by increases in food prices. Food and non-alcoholic drink prices were up by 4.2% in the year to December 2021. The Monetary Policy Committee has stated that food price inflation is expected to increase in coming months, given higher input costs. It has been estimated by the thinktank, Food Foundation, that 4.7m Britons, equivalent to 8.8% of the population, are struggling to feed themselves and are regularly going a day without eating.

Supermarkets have also raised their concerns about future increases. Tesco’s chairman John Allan has predicted that the worst is yet to come, pointing to 5% as a likely figure for food price inflation by the spring. He cited high energy prices, both for Tesco and its suppliers, as a key factor behind the expected rise.

It has been observed that the Smart Price, Basics and Value range products offered by supermarkets as lower-cost alternatives are stealthily being extinguished from the shelves. This is leaving shoppers with no choice but to ‘level up’ to the supermarkets’ own better-quality branded goods – usually in smaller quantities at larger prices. The managing director of Iceland, Richard Walker, has stated that his stores are not losing customers to other competitors or to better offers, but to food banks and to hunger. This is a highly concerning statement given that 2.5m citizens were forced by an array of desperate circumstances to use food banks over the past year.

Rent
Private rents are also rising at their fastest rate in five years, intensifying the increase in the cost of living for millions of households. Data from the ONS reveal that the average cost of renting in the UK rose by 2% in 2021. This was the largest annual increase since 2017. The East Midlands had the biggest increase in average rental prices, with tenants paying 3.6% more than a year earlier. However, due to falling demand for city flats during lockdown, as people favoured working from home, London had the smallest increase at 0.1%. Nevertheless, as Covid restrictions are removed, renters, including office workers and students, are now returning back to cities. This is now pushing up rental prices with demand outpacing supply.

The property website Zoopla found newly advertised rental prices were rising much faster across the UK. It said the average rent jumped 8.3% in the final three months of 2021 to £969 a month. This increase in rental prices, combined with the general rise in prices will place additional pressure on the government to increase support for vulnerable families. The housing charity, Shelter, has reported an increase in people who are struggling to pay their rent and even pay their electricity. With Covid-era protections having ended, if people struggle to pay, they are faced with eviction or even homelessness. There are calls for the government to support such people by reversing welfare cuts.

Insurer, Legal & General, has announced an additional investment over the next 5 years of £2.5bn on its ‘build to rent’ schemes. The aim is to provide more than 7000 purpose-built rental homes in UK towns and cities. L&G claims that the additional homes are part of the solution to the rental problem, with rent increases being capped at 5% for five years. However, sceptics claim the company is simply trying to cash in on the booming market and there are calls for further government action. The Joseph Rowntree Foundation claim that renters will struggle as rents in some areas have risen as much as 8%. Despite this, housing benefit has been frozen for two years and therefore there are calls for government to urgently relink housing benefit to the real cost of renting.

Articles

Questions

  1. What other measures of inflation are used beside CPI inflation? How do they differ?
  2. If all consumers are facing approximately the same price increases for any given good or service, why are poor people being disproportionately hit by rising prices?
  3. For what reasons might the rate of inflation (a) rise further; (b) begin to fall?
  4. Examine a developed country other than the UK and find out how inflation is affecting its population. Is its experience similar to that in the UK? Does it differ in any way?