Good morning from New Economy Brief.
2024 started with businesses optimistic about the UK's economic recovery and hopes that inflation was under control. But last week's figures showed inflation actually rose slightly and economists are warning that the crisis in the Red Sea could ‘shatter hopes of global economic recovery’.
This bout of inflation was triggered by Russia’s invasion of Ukraine, and the recovery from it has always been vulnerable to events. UK Prime Minister Rishi Sunak recently warned the world is “the most unstable it has been in decades” as part of his justification for airstrikes on Houthi targets in Yemen, and others say we are entering a new era of geopolitical instability and that macroeconomic models still haven’t caught up to this new reality.
This week’s New Economy Brief looks at what happens to economic modelling and monetary policy institutions in a world where geopolitics and climate change create new challenges and regular supply shocks. Or in other words, how should policy adapt to a new world of permanent instability and higher inflation?
Hopes of recovery? Last week The Times reported a renewed sense of optimism in the UK’s economic recovery after over a year of record inflation and stagnant growth, with financial markets expecting interest rates to fall from a 15-year high of 5.25%. Some are even predicting inflation to drop back to the BoE’s 2% target by April. However, the latest figures showed inflation rose slightly to 4% rather than falling as expected. Financial markets now expect this to move down to 2% later in Spring.
Geopolitical instability and supply shocks. Experts at Brookings argue that “geopolitical tensions have become the single most important risk confronting the global economy” in 2024, with wars in “two regions critical to the world’s food and energy supply”. Conflict in the Red Sea has already led to supply shortages and trade frictions in the Suez Canal, which accounts for 30% of global shipping container traffic. These developments again show that inflation can arise from unpredictable external events over which institutions like the BoE have little control. Can our institutions respond to this new inflationary environment?
UK institutions haven’t adapted to new instabilities. The Bank of England is mandated to increase interest rates and constrain economic activity when inflation is higher than its 2% target. The question of when and how to act largely turns on your view of whether the inflation is ‘transitory’ or ‘persistent’- i.e. is high inflation just a temporary shock that will resolve itself, or is it so embedded within the economy that more determined action is needed? Much of the economic debate over how to respond to inflation has focused on this question, with (very crudely) Team Persistent arguing for higher rate rises to crush core inflation, while Team Transitory called for price caps and other strategies to contain the impact of high energy prices and stop it spreading to other areas of the economy.
Rising UK interest rates won’t solve global problems. And yet, the BoE’s price stability mandate encourages it to increase interest rates whenever inflation rises over 2%. Increasing interest rates makes borrowing more expensive, limiting both public and private investment. As explained above, across the world, many countries are accelerating investments in industrial policy to ease supply bottlenecks, but conventional monetary policy is pulling in the opposite direction.
Anti-inflationary policy for an unstable global economy. Christine Lagarde, President of the European Central Bank, argued in a speech at last year’s Jackson Hole Economic Symposium on Policymaking in an age of shifts and breaks that “we will have to establish new frameworks geared towards robust policymaking under uncertainty”. If instability is now the norm, perhaps it is time to rethink our monetary policy institutions and how economies respond to bouts of inflation and supply-shocks?
A progressive green growth narrative. A stronger story is needed to convince the country of Labour’s Green Prosperity Plan, urges Mariana Mazzucato. She argues that the £28 billion Labour has pledged to the programme “must be seen as an investment in the country’s financial future”, rather than a cost that will be difficult to meet.
A lesson from France and Spain. The New Economics Foundation’s Paulo Yunda believes the UK could take a lesson in how to fight the cost of living crisis from the French and Spanish governments. Measures like rent caps, subsidised rail and bus fares and tax credits for people buying electric vehicles helped both countries keep inflation below UK levels in 2023.
Dual rates for green lending. European Central Bank executive board member Isabel Schnabel has indicated that the bank could consider dual interest rates for green lending. This comes after European civil society organisations and academics renewed calls for dual rates for green lending in a letter to French President Emmanuel Macron last month.
Wealth taxes won’t make the super rich leave. According to new qualitative research by the London School of Economics, based on interviews with members of the UK’s richest 1%, higher taxes would not tempt the super rich to run away to tax havens as is so often suggested. Respondents said they would stay in the UK because they would be “bored to death” in tax havens, and judged tax migrants “on moral grounds”.
Public investment, not tax cuts. The UK should invest £26 billion a year in a low-carbon economy instead of planning tax giveaways that will only cause further stagnation, leading economists from LSE have advised. Similarly, a survey conducted by Conservative donor and peer Lord Ashcroft showed that if the government found it had more money than expected, 54% of voters would want the surplus to be spent on public services, compared to just 25% who demanded “tax cuts for people like me”. The poll also showed that even those who voted Conservative in 2019 prefer spending on public services to tax cuts by 44% to 28%.
Women are twice as likely to miss out on statutory sick pay. Across the UK, 1.3 million people don’t qualify for statutory sick pay because they earn less than £123 a week – and 7 in 10 of them are women, according to new research by the Trades Union Congress (TUC). The figures show that 6.5% of women earn too little to receive statutory sick pay, compared to just 2.8% of men.
UK Poverty 2024. The Joseph Rowntree Foundation (JRF) has published its UK Poverty 2024 report, using a range of data sources and insights to build up a comprehensive picture of the state of poverty across the UK. It finds that poverty has increased almost to pre-pandemic levels, and notes that it has been six prime ministers and almost 20 years since poverty last fell consistently over a prolonged period.