My Lords, it is a pleasure to follow the noble Lord, Lord Hunt. I will make some remarks on the macroeconomic aspects of the economic challenge that we face.
Of course, we all know that this is a dual economic crisis: it is a crisis at household level as inflation soars—it is predicted to exceed 10% in a few months—and it is a macroeconomic crisis of stagflation, or inflation and constrained growth combined. No one should pretend that addressing stagflation is easy if you are in power, as a lot of the people on these Benches know from the past. To some extent, this is of course a global challenge and not a UK one, although I take the comments of the noble Lord, Lord Forsyth, on this issue, which were as stimulating as ever. But it is important to understand that there is a UK variant of this economic shock if we are going to get the policy-making response right. That is what I want to talk about briefly today.
Of course, everyone has suffered from two huge impacts—Covid and the Ukraine war—and the supply problems and commodity shocks that have come from those two crises. But, to understand how the UK should respond, we have to understand three things. First, we have to understand how serious the risks of recession are, as economic activity slows down, as well as the dangers that come with escalating prices. Secondly, we have to understand how much domestic inflation is caused by these external shocks and how much is caused by wages chasing inflation. Thirdly, we have to understand what country-specific factors lie behind inflation in the UK.
On the first issue, the risk of recession, most commentators, including the Bank of England—to the extent that it is a commentator—say that we are on the brink of a recession, or at least a very significant slow-down. The second largest hit to household incomes
since records began is coming our way. Consumer confidence is at the lowest it has been for nearly 50 years. The OBR says that living standards will fall by the largest annual amount since records began 65 years ago. In my view, the risks of recession should worry policymakers as much as inflation. I suspect that, in six months, they will worry us much more.
On the second point, of how much inflation is driven by supply shocks versus a wage-price spiral—various people have talked about this issue—the evidence is quite complicated. The UK is an odd case in this regard because, like the US, where economists suggest there is clear evidence of excess demand as wages chase prices across the economy, the UK has tight labour markets and inflation is well above target. But unlike the United States, there is little evidence so far that our inflation is at the moment being fuelled by a wage-price spiral. The latest ONS data in February shows that regular pay fell year on year in real terms. The one area in which that is not true, by the way, is financial services, where large bonuses have kept overall pay growth higher. However, we do not at the moment have a systemic economy-wide wage-price spiral problem—though that is not to say we should be complacent. But we have a serious problem of lagging real wages in much of our economy, which is a key issue because it means that the Government have much more fiscal room to counter an upcoming recession than they might think.
On the third issue, the UK-specific factors behind inflation, again the UK is an odd case in one important respect—Brexit. Brexit has caused UK-specific inflationary pressures, and for a few reasons: the depreciation of sterling in the aftermath of the referendum; additional barriers at the border; raised costs; and trade barriers protecting domestic producers from efficient competition. What we have not seen, interestingly, is inflation driven by the labour shortages that Brexit accentuated. IFS studies suggest that, with a couple of exceptions, those have not led to accelerating wage growth.
That is the bad news. The good news is that we do not have a broad-based spiking of wages due to a Brexit that is causing raging inflation. This suggests that, while inflation is causing huge pains to millions of households, the far bigger risk for the UK is the unhappy combination of energy price hikes, higher food prices, fiscal tightening and monetary tightening, all leading by the end of the year to a serious slowdown and even recession. A concern about the horrific impact of the cost of living crisis on struggling families and a macroeconomic concern about the dangers of reinforcing the drift towards recession point the same way, in my view: towards the Government taking urgent, sizeable steps to stimulate the economy. By far the most efficient and targeted way of doing this is through not tax cuts but the benefits system, helping those who need it most and whose incomes are not keeping up with rising prices, who have no savings to rely on and no access to other wealth. This could be financed in various ways, such as through borrowing or the windfall tax, which noble Lords would expect me to talk about.
I will say one last word on the windfall tax. If it is designed properly and targets genuine, supernormal profits, the idea that it will undermine investment is
incorrect because investment plans do not rely on supernormal profits. If they do, they are not very good investment plans. Spain, Italy, Bulgaria and Romania have introduced them and France has enforced big price reductions on EDF. Germany’s coalition is debating one and Biden’s congressional Democrats have proposed one. From what Ministers have said in public, in coded and less coded ways, I am actually hopeful that the UK looks like it may follow suit. If so, it will be not just for the families but for the macroeconomic health of our economy that it happens.
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