Sticky UK inflation is a political headache for Rishi Sunak’s government. Soaring interest rates are hurting mortgage-holders, and renters as their landlords pass on higher borrowing costs.
(Bloomberg) — Sticky UK inflation is a political headache for Rishi Sunak’s government. Soaring interest rates are hurting mortgage-holders, and renters as their landlords pass on higher borrowing costs.
Voters would also suffer if the Bank of England triggers a recession, as Governor Andrew Bailey signaled Thursday he’s prepared to do if that’s what it takes. With a general election expected next year, Sunak has a major vested interest in getting inflation dealt with as quickly as possible.
That explains why members of Sunak’s Conservative Party have lashed out at the central bank, which they say has primary responsibility. But the prime minister does have options to help — if he is willing to ignore the politics.
Do No Harm
The first – and simplest – thing the government can do is not to aggravate inflation by increasing public spending. No additional investment, and wage restraint where possible. No tax cuts, despite all the Tory calls for a pre-election handout. It’s what Chancellor of the Exchequer Jeremy Hunt is doing, though the government is paying the price with widespread strike action.
“We will continue to ensure that fiscal policy remains aligned to monetary policy by controlling public sector borrowing,” he wrote in an exchange of letters with Bailey. “This will require continued discipline on public spending and tax policy. Increased borrowing would add to inflationary pressures.”
Boost Immigration
Inflation is stickier in the UK than any major advanced economy because it is embedded in domestic price setting. The main mechanism for that has been the tight labor market, where regular private sector pay is growing at 7.6% — a level that is incompatible with the 2% inflation target.
The problem is the shortage of workers, meaning staff can demand pay rises by threatening to move jobs. Increase supply, for example by reintroducing freedom of movement with the European Union, would solve it. But stopping that was a core Brexit argument, so Sunak would risk a Conservative mutiny.
Slash Benefits
Another way of addressing the tight labor market might be to cut working-age benefits, to give those out of work little option but to find a job. There are 350,000 more economically inactive people in the UK than before the pandemic. They are not looking for work, many on the grounds of ill health.
In the March budget, the government tried the carrot of childcare support and pension giveaways to bring parents and older workers back into the labor force. But its effect was limited. It could now try the blunt stick of docking benefits — while bracing itself for a dramatic voter backlash.
Raise income taxes
Advocates of Modern Monetary Theory argue that the way to tackle high inflation is to raise taxes instead of interest rates. Tax rises work the same way, by squeezing household spending, but have the added benefit of improving the public finances by raising income for the government.
Using the same argument, the government could aid the BOE by raising taxes to bear down on consumption. But could any government recover from the political backlash of taking money out of people’s pockets just as prices rise?
Wage, Price Controls
The government could issue a legal order for all companies to freeze prices and wages for a fixed period, as US President Richard Nixon did in 1971. In the short term, it worked. Prices stopped rising, but only by storing up longer-term problems. Removing the controls proved difficult as companies tried to recover lost profits and workers sought improved living standards. High inflation quickly returned — though that was after Nixon had won a second term.
Could Sunak repress his party’s free market instincts? A softer version would be targeted price controls using government subsidies. The Energy Price Guarantee introduced after Russia’s war in Ukraine was effectively that, and did reduce inflation. There was talk of a food-price cap, though the government has backed away from the idea. Another option would be to scrap VAT, although doing so would probably backfire as households spent more.
Tiering BOE Reserves
The Bank of England created hundreds of billions of pounds through quantitative easing, which it put on deposit for commercial banks. The central bank pays interest on those deposits, known as “reserves,” which boosts high street lenders’ profits. Some economists have suggested the government change the arrangement and pay interest on only some of reserves.
It would cut banks’ profits, which they would try to recoup by raising the rate charged on loans and lowering the rate paid on savings. That would take money from borrowers without giving any to savers, acting like a rate increase without the BOE doing anything. It would also give the chancellor more fiscal headroom as QE is a drain on the nation’s coffers. Sunak’s Tories might balk at being seen to tax the banks — though some voters could find that appealing.
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