How to tackle the UK cost of living crisis – four economists have their say

Inflation in the UK could reach 13 percent in October, after reaching 40-year highs. according to Bank of England forecasts. While inflation has not kept pace with wages, rising energy costs are a major reason for the expected squeeze on households as well as businesses.

Retail charges for both households and businesses have been impacted by a rise in wholesale energy prices. The government sets a price limit to protect consumers from sudden increases in energy prices, but it increases according to market rates. This could cause average household bills to increase by more than £650 in January 2023 to the equivalent of £4,266 for the year.

All major UK parties have offered proposals to alleviate the cost-of-living crisis. Four economists were asked to discuss the suggestions and to outline the measures that they believe would help ease some of the pressure on UK businesses and households this year.

Winter rationing and price control

Alan Shipman is a senior lecturer in economics at the Open University

“If left to the market, energy costs will soon rise so fast that price controls may be the new prime minister’s only option this winter. One way to avoid fuel poverty is to have a lower price cap than Ofgem, the regulator.

Similar to the former prime minister Gordon Brown’s proposal, this would work. After assessing the profit margins and operating expenses of energy suppliers, the government would negotiate new prices with them.

A lower price cap could cause some suppliers to go under, forcing the government either to bail them out of bankruptcy or take them over. This was already happening before this latest rise in wholesale price.

Ofgem admitted that the market review in 2019 was too lax and that it had not required new entrants with more risky business models. Price controls would help to distinguish viable operators from those who need to close down or join Bulb Energy’s effective public ownership.

A tighter price cap could also limit the amount of gas distributors and power generators could profitably buy on wholesale markets. If the remaining supply is not rationed, this could lead to shortages. EU countries have already begun to plan to limit industrial gas use during winter peak seasons, anticipating that Russia would close its pipelines as the temperature drops.

Protests have been raised in Germany, where chemical and steel producers are negotiating for exemptions from the possibility of shutting down fuel-saving factories. But a recession due to silent factories is likely to be shorter and less socially damaging than the one that will follow from letting the number of households in fuel poverty this winter rise above 8m if prices are not controlled.”

Prioritize the energy transformation

Adi Imsirovic is a senior research fellow at the Oxford Institute for Energy Studies (University of Surrey).

“A coherent policy to reduce the predicted explosion in fuel bills this winter must also ensure energy security and still facilitate the transition to cleaner sources of heat and power. At the moment, none of the UK’s top politicians have such a policy.

Current government policy of a price cap, lower VAT payments and encouragement consumption encourages consumption. It also supports rich households that use more electricity. Fossil fuel subsidiesEnergy companies should be discouraged from investing in low-carbon resources. By scrapping fossil fuel subsidies amounting to some £10.5bn per year, targeted cash payments could be given to vulnerable households instead.

Of the proposals from both Conservative party leadership contenders, Rishi Sunak’s targeted help for poor households is a better option cost-wise than Liz Truss’s tax cuts. However, his proposal to reduce VAT on energy by further subsidizing fossil fuels and encouraging consumption would be detrimental to the environment.

Instead of receiving cash payments for vulnerable households, you could scrap fossil fuel subsidies.

Labour’s proposed extension of windfall taxes is arbitrary – why not tax Google, Meta, law firms or any of the many other companies that announced significant profits recently? Taxing domestic producers such EDF or Centrica could discourage investment in cleaner fuels, such as nuclear or gas here in the UK.

Labour’s most recent proposalLiberal Democrats also favor a price freeze as a policy option. A price freeze would be the worst choice for climate transition.

It would prolong dependence on fossil fuelsSupporting demand would benefit Russian production. Subsidize wealthy households that use and waste the most energy. Eventually, price freezes may also lead to shortages if suppliers are unable to purchase energy in the wholesale markets at or below the frozen price.”

Be sure to target the most vulnerable

Morten Ravn is Professor of Economics, University College London

“Under the current conditions of rising living costs and a monetary contraction (when the Bank of England raises interest rates to cool the economy), it is tempting for a government to provide a fiscal stimulus – cutting taxes or raising spending – to soften the blow to the economy. This is because it could increase inflation by encouraging people and businesses spend more money.

Therefore, targeted policies would be most effective right now. Higher inflation and the cooling effect of the economy caused by higher interest rates tends to be more detrimental to households with lower incomes.

Such households’ consumption baskets usually have more price sensitive goods (energy, fuel and commodities) and are more likely to be affected by the income squeeze. This group could be targeted with policies that help the economy cope with the crisis and protect the most vulnerable.

Targeted policies would be most useful right now

This is why Liz Truss’s Bank of England reform proposal would not be acceptable. The Bank of England’s most urgent job at the moment is to protect its reputation for being able to provide low and stable inflation and this requires protecting its current status.

Both Truss, Sunak, and Truss expressed a desire reduce taxes. Truss’s plan to do this soon would likely make the Bank of England’s job more difficult by forcing it to raise rates higher and faster.

Sunak’s desire to make a tax cut further down the line could exacerbate the cooling of the economy in the meantime as it would effectively imply a high tax rate today relative to the future encouraging people to put off spending now. However, neither Truss or Sunak have made clear how their tax reforms will be funded. This makes it difficult to evaluate the consequences.

Overall, each of the current plans are missing a commitment to quick implementation to protect the most vulnerable groups of society during the very challenging economic situation we are seeing right now.”

Look for growth and investment

Shampa Roy-Mukherjee is an associate professor in economics at the University of East London

“The Tory leadership race has used the country’s dire economic situation and the cost of living crisis as political football. Both candidates have offered economic policies that they believe would appeal to 160,000 Conservative party members, who are predominantly white, wealthy, British men with an average age 57 years.

The debate surrounding the Tory leadership contest has largely focused on tax policy. Liz Truss is the frontrunner in the contest. She claims that her tax cuts would lead to economic growth, and help avoid the recession predicted by the Bank of England.

However, if the economy fails show significant and sustained growth, these tax reductions could lead to further cuts in public services and wages, as well higher borrowing. They could also increase inflation by encouraging people to spend more and businesses to borrow more.

Rishi Sunak, the other contender, proposes to lower taxes once inflation has been under control. He proposes to cut 3p from income tax by 2029 (instead of the 1p cut promised in April). However, his plan is lacking in details and would only be beneficial to those who are employed. The economic consequences of these tax cuts could be similar to those proposed by Truss if they are not backed with strong economic growth, which leads to higher taxes revenues.

Both candidates have not proposed supply side policies that prioritize innovation, growth, and inward investment. This could include labour market flexibility, upskilling workers, and trade openness.

Such measures would encourage growth and help combat inflation by increasing competitiveness, efficiency, productivity and ultimately real wages – all of which have been negatively affected by Brexitand the Covid pandemic. Failure to address supply side issues could lead to further reductions in productivity and real wages in the decade ahead.”

This article was republished by The Conversation under a Creative Commons licence. You can read the original article.

Main image: Alexander Dummer