6 January 2022

Calm down about the ‘overnight cost of living crisis’

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Most commentators were complacent about the risks of higher inflation in 2021 and seem determined not to be caught out again this year. But some of the rhetoric is now running well ahead of reality.

Take the warnings that UK families are facing an ‘overnight cost of living catastrophe’. It is true that many are likely to suffer a significant hit to their real disposable incomes from April onwards, as a result of higher energy bills and tax rises. The Resolution Foundation has estimated that these will cost an average of £1,200 per household.

Nonetheless, this will not happen ‘overnight’, it is not primarily about the ‘cost of living’, and it is not necessarily a ‘catastrophe’ either.

This is more than mere quibbling over the precise choice of words to describe what might happen. A proper understanding of the problems is key to assessing the risks to the economy and how policy should respond.

Note first that the hit to incomes would be spread over the course of the year, so families would not have to find £1,200 straightaway. A lot else could also happen over this period, including a renewed decline in energy prices (remember that the cap is a ceiling, not a floor, and will be reviewed during the year), and a renewed acceleration in real wages. In the meantime, the jobs market remains strong.

Second, the £1,200 figure is a mix of energy price rises and tax hikes, notably the 1.25% increase in National Insurance Contributions (NICs). It is therefore not just about ‘the cost of living’.

Indeed, the bulk of the increase in inflation has already happened: the CPI measure might rise to around 6%, but it was 5.1% last November. And aside from energy prices, there are tentative signs in business surveys that other cost pressures are beginning to ease.

‘Catastrophe’ is too strong a word as well. As the Resolution Foundation itself points out, the burden of the increase in NICs will fall mainly on middle and higher-income households, not the poorest.

I would add that many will be able to dip into pandemic savings to maintain their living standards during a temporary squeeze on their real incomes. Fading fears over Covid and increasing job security should give them the confidence to do so too.

That said, the Government may have to do more to protect low-income households. These households are, of course, more vulnerable to energy price hikes, because they spend a larger share of their income on energy, and are least likely to have a cushion of savings to tide them over.

However, the Government has already taken some action here. The temporary uplift of £20 to Universal Credit has been withdrawn, but changes to the ‘taper’ mean that people will be able to keep more of their wages as they earn more.

April will also bring a relatively large increase in the National Minimum Wage, protecting the real wages of many workers on the lowest incomes. The energy price cap, for all its flaws, has at least shielded households in the UK from the worst of the surge in global costs over the last few months.

Perhaps there is still more that could be done. One approach would be to find some way to limit the increase in energy prices coming in April, but there is no painless way to do this. As Ben Ramanauskas has already argued here, cutting VAT on energy would not have much impact on bills, and would not be well-targeted anyway.

In any event, it would not make sense to shield everyone from the full impact of higher energy costs. Markets and price signals still need to be allowed to do their job of balancing supply and demand.

This suggests that the main emphasis should be on protecting the most vulnerable, rather than limiting the rises for all regardless of ability to pay, which is a task for the benefit system. One option here would be to reinstate the temporary uplift to Universal Credit, but at £5 or £10 a week rather than £20, or top up other subsidies to those on low incomes.

There is a case too for delaying the increase in NICs for a year (as suggested by Jacob Rees-Mogg, among others). Even if NICs were the best way to finance long-term reforms to social care (and few think it is), the money will initially be used to tackle the backlog in NHS work due to the pandemic. This is a one-off cost that could reasonably be added to long-term borrowing, rather than paid for from current taxation.

Otherwise, though, there are good reasons to think that a temporary period of higher inflation is unlikely to squeeze the life out of the economy, and that only a little more support is required to protect the poorest from higher energy prices. Policy should not be dictated by scary headlines and dodgy soundbites.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.