Emergency measures to reduce RPI
The near-term economic climate the UK faces poses material challenges that need both tactical and strategic thinking, and a joined-up approach to address this national emergency around energy in particular. The latest forecast from the Bank of England suggests that inflation will peak at 13.3% in October, and remain high throughout 2023, exacerbating a cost-of-living crisis where real disposable incomes are projected to fall more than at any time in around 60 years.
Whilst there are, as ever, many moving parts, the immediate need is to prevent annual household energy bills of £4,200+ becoming a reality. The welfare of households and businesses should be at the heart of the emergency thinking in the short term, alongside the need to control RPI inflation to prevent the mushrooming of index-linked commitments and higher wage inflation.
This paper puts forward various recommendations that seek to control RPI inflation. Amongst other things, RPI inflation feeds directly into pensions; it’s the figure commonly used for wage negotiations, so it affects labour inflation, which feeds into wider economic activity; and it determines the repayments on index-linked gilts, which are a concerningly large draw on government expenditure. Interest rates are belatedly on the rise. Monetary policy will be the main tool to tackle inflation, but this will take time to take effect.
A key point to understand is that RPI is just a number – a method of calculating inflation which isn’t internationally recognised and is widely viewed as having drawbacks. One can constructively influence the figure by altering the prices of the various components, and this is one reason why, for example, the US Government is introducing measures to lower the cost of prescription drugs in its new Inflation Reduction Act. As such, this short paper proposes specific interventions around energy, labour, welfare and public finances that, cumulatively, would (hopefully) begin to reduce RPI inflation whilst helping to support the reputation, and so the value, of sterling for the UK to also be a place of sound governance.
Energy costs
Turning to the domestic energy emergency, this is an issue for householders and businesses alike and needs urgent attention. The timing of the Conservative Party’s leadership election is unfortunate in this respect, but it should not prevent the Government from taking necessary urgent action to deal with a real economic, social and (potentially) political emergency.
Countries such as Germany are rightly treating the spike in energy prices as a national emergency. It is reopening coal-fired power stations and sourcing alternative supplies of gas and oil despite being led by a coalition that includes the Green Party. The French Government has renationalised EDF, and capped energy prices, to minimise the economic impact of the energy price shock, contributing towards significantly lower inflation in France than in Britain, Germany or the United States. And Japan is dealing with the energy crisis by restarting nuclear power stations and expanding other renewable sources of energy in order to expand supply.
Here in the UK, Ofgem seems to be more concerned about keeping energy companies solvent than helping the consumers of energy (businesses and households). Increasing the energy price cap this autumn would be disastrous for both customers and inflation, and it shouldn’t be forgotten that it doesn’t apply to businesses. There is a strong argument for taking Ofgem out of the equation and keeping the price cap at the current level and extending it to businesses.
The level of taxation on energy and fuel should also be considered. A huge proportion of the price paid at the motor fuel pump is taxation, which is levied as a proportion of the overall cost. How much was the Treasury anticipating raising from energy taxes at the last Budget, from the punitive green levies to VAT on energy bills and fuel? With the recent price spikes, has that estimated tax revenue already been raised? Is the Government itself now earning ‘supernormal’ profits? If so, there’s a strong case for temporarily reducing these taxes significantly, to reduce the price, and thus reduce the contribution energy makes to RPI inflation.
The energy market in the UK – Ofgem included – is a construct of government, and only the state can intervene at a scale and pace necessary at this time to deal with the impending emergency. Analogies that may be helpful in setting the necessary mindset here are the interventions into the banking system at the time of the Great Financial Crisis and the creation of the furlough scheme during the Coronavirus pandemic. It is laudable that the Government’s instinct is to minimise market interventions, but this emergency has come about significantly because of Russia’s invasion of Ukraine, giving the Government the mandate to consider policies that would usually be off the table in peacetime.
A big intervention, that will be very considerable in terms of national debt commitments and will need an evolving approach from a strategic perspective to improve the prospects and productivity of the British economy, including its public services, is necessary. The precise cost of the maximum energy price is a matter for more defined thinking, but the magnitude of intervention needs to cover a significant chunk of the £4,200+ annual household cost that is being purported by some domestic energy modelling from January 2023.
As with all inflationary situations, the way out of this energy crisis is obviously to increase supply and also, in the short term, subdue demand. On the supply side, getting gas storage back up and running must be an immediate priority, as should stockpiling diesel to keep hospitals and data centres running through any blackouts. On the demand side, working out the balance between household and business energy rationing must be a priority, in the event of a worst-case scenario. It is notable that the Spanish Government has mandated businesses, hotels, restaurants and so forth to curb air conditioning to c27˚C to try and cut energy utilisation by c4-5% when shade temperatures are c40˚C. And in Germany, thermostats in offices and housing developments will be turned down lower than usual as the weather turns cooler. These price spikes will pass, but radical action is required in the meantime. And for the medium term, homes should be insulated, fracking should be permitted, and we should be taking full advantage of the energy resources still available in the North Sea.
Food prices
The price of food is also a significant contributor to RPI inflation. How can food prices be reduced? One reason why the energy price cap should be extended to businesses is because higher energy prices feed through into higher prices generally, through the multiplier effect. This is especially the case in the food sector, where high energy costs are one of the key drivers of higher food prices (the increase in the price of bread is a good example), so action on energy should feed through to lower food prices.
Cutting/abolishing tariffs on imported foodstuffs, particularly food not produced in the UK, is also an obvious move. If it is felt that these tariffs are important for trade negotiations, they can be reintroduced down the line, but the most immediate issue is tackling inflation, so they are easy wins for price reductions. Supermarkets who fail to pass on the price reductions should be called out for prioritising their own bottom line over the need to tackle inflation.
The near-term economic climate the UK faces poses material challenges that need both tactical and strategic thinking, and a joined-up approach to address this national emergency around energy in particular. The latest forecast from the Bank of England suggests that inflation will peak at 13.3% in October, and remain high throughout 2023, exacerbating a cost-of-living crisis where real disposable incomes are projected to fall more than at any time in around 60 years.
Whilst there are, as ever, many moving parts, the immediate need is to prevent annual household energy bills of £4,200+ becoming a reality. The welfare of households and businesses should be at the heart of the emergency thinking in the short term, alongside the need to control RPI inflation to prevent the mushrooming of index-linked commitments and higher wage inflation.
This paper puts forward various recommendations that seek to control RPI inflation. Amongst other things, RPI inflation feeds directly into pensions; it’s the figure commonly used for wage negotiations, so it affects labour inflation, which feeds into wider economic activity; and it determines the repayments on index-linked gilts, which are a concerningly large draw on government expenditure. Interest rates are belatedly on the rise. Monetary policy will be the main tool to tackle inflation, but this will take time to take effect.
A key point to understand is that RPI is just a number – a method of calculating inflation which isn’t internationally recognised and is widely viewed as having drawbacks. One can constructively influence the figure by altering the prices of the various components, and this is one reason why, for example, the US Government is introducing measures to lower the cost of prescription drugs in its new Inflation Reduction Act. As such, this short paper proposes specific interventions around energy, labour, welfare and public finances that, cumulatively, would (hopefully) begin to reduce RPI inflation whilst helping to support the reputation, and so the value, of sterling for the UK to also be a place of sound governance.
Energy costs
Turning to the domestic energy emergency, this is an issue for householders and businesses alike and needs urgent attention. The timing of the Conservative Party’s leadership election is unfortunate in this respect, but it should not prevent the Government from taking necessary urgent action to deal with a real economic, social and (potentially) political emergency.
Countries such as Germany are rightly treating the spike in energy prices as a national emergency. It is reopening coal-fired power stations and sourcing alternative supplies of gas and oil despite being led by a coalition that includes the Green Party. The French Government has renationalised EDF, and capped energy prices, to minimise the economic impact of the energy price shock, contributing towards significantly lower inflation in France than in Britain, Germany or the United States. And Japan is dealing with the energy crisis by restarting nuclear power stations and expanding other renewable sources of energy in order to expand supply.
Here in the UK, Ofgem seems to be more concerned about keeping energy companies solvent than helping the consumers of energy (businesses and households). Increasing the energy price cap this autumn would be disastrous for both customers and inflation, and it shouldn’t be forgotten that it doesn’t apply to businesses. There is a strong argument for taking Ofgem out of the equation and keeping the price cap at the current level and extending it to businesses.
The level of taxation on energy and fuel should also be considered. A huge proportion of the price paid at the motor fuel pump is taxation, which is levied as a proportion of the overall cost. How much was the Treasury anticipating raising from energy taxes at the last Budget, from the punitive green levies to VAT on energy bills and fuel? With the recent price spikes, has that estimated tax revenue already been raised? Is the Government itself now earning ‘supernormal’ profits? If so, there’s a strong case for temporarily reducing these taxes significantly, to reduce the price, and thus reduce the contribution energy makes to RPI inflation.
The energy market in the UK – Ofgem included – is a construct of government, and only the state can intervene at a scale and pace necessary at this time to deal with the impending emergency. Analogies that may be helpful in setting the necessary mindset here are the interventions into the banking system at the time of the Great Financial Crisis and the creation of the furlough scheme during the Coronavirus pandemic. It is laudable that the Government’s instinct is to minimise market interventions, but this emergency has come about significantly because of Russia’s invasion of Ukraine, giving the Government the mandate to consider policies that would usually be off the table in peacetime.
A big intervention, that will be very considerable in terms of national debt commitments and will need an evolving approach from a strategic perspective to improve the prospects and productivity of the British economy, including its public services, is necessary. The precise cost of the maximum energy price is a matter for more defined thinking, but the magnitude of intervention needs to cover a significant chunk of the £4,200+ annual household cost that is being purported by some domestic energy modelling from January 2023.
As with all inflationary situations, the way out of this energy crisis is obviously to increase supply and also, in the short term, subdue demand. On the supply side, getting gas storage back up and running must be an immediate priority, as should stockpiling diesel to keep hospitals and data centres running through any blackouts. On the demand side, working out the balance between household and business energy rationing must be a priority, in the event of a worst-case scenario. It is notable that the Spanish Government has mandated businesses, hotels, restaurants and so forth to curb air conditioning to c27˚C to try and cut energy utilisation by c4-5% when shade temperatures are c40˚C. And in Germany, thermostats in offices and housing developments will be turned down lower than usual as the weather turns cooler. These price spikes will pass, but radical action is required in the meantime. And for the medium term, homes should be insulated, fracking should be permitted, and we should be taking full advantage of the energy resources still available in the North Sea.
Food prices
The price of food is also a significant contributor to RPI inflation. How can food prices be reduced? One reason why the energy price cap should be extended to businesses is because higher energy prices feed through into higher prices generally, through the multiplier effect. This is especially the case in the food sector, where high energy costs are one of the key drivers of higher food prices (the increase in the price of bread is a good example), so action on energy should feed through to lower food prices.
Cutting/abolishing tariffs on imported foodstuffs, particularly food not produced in the UK, is also an obvious move. If it is felt that these tariffs are important for trade negotiations, they can be reintroduced down the line, but the most immediate issue is tackling inflation, so they are easy wins for price reductions. Supermarkets who fail to pass on the price reductions should be called out for prioritising their own bottom line over the need to tackle inflation.
Another factor in higher food costs is the restricted supply of labour for key elements of food production, from picking fruit, to slaughtering animals, to driving trucks. The harvest season for apples and pears is coming up, for example, as is the need for butchers to slaughter turkeys for Christmas. A sufficient number of seasonal worker visas need to be available for the coming year. Supermarkets would also, we are sure, discuss with the Government reintroducing business rate relief for grocers for direct pass-through into lower food prices.
In terms of the general labour market, it is not operating optimally at the moment, and the medium-term goal needs to be encouraging British people who are able to work to come off benefits. The incentive to work over staying on state benefits would appear to be too low, thus tightening labour markets and boosting the price of this factor of production, which is also inflationary. There may therefore be grounds to look at improving the taper rate for workers within the Universal Credit system support to increase the incentive to work, increasing the supply of labour, so assisting the performance of businesses and reducing inflation.
Other considerations
Turning to the macro picture, the value of sterling also has a very important bearing on inflation. Gaining the confidence of the currency markets is crucial. Conveying a convincing growth narrative, which includes supply side reform (as has been commendably discussed extensively in the leadership contest), is essential. The short-term measures described above should be announced in the context of sound money and strong economic growth. The UK needs to be in behaviour and perception a place where the economy is effectively managed.
Voters also need to be reassured that the Government is taking inflation and the cost-of-living crisis seriously. COBRA is used to address national emergencies, so it should also be used to tackle the cost-of-living crisis – a national economic emergency the country faces. This level of attention and grip would reassure voters that the Government is properly tackling a crisis that is keeping many people up at night.
Recommendations
We are in an emergency and big decisions need to be taken at pace to get a grip on the energy crisis and the adverse effect it is having on RPI inflation. Our recommendations include:
- Direct state intervention into the commercial and household energy markets, akin to the involvement in the banking sector and furlough, for as long as necessary.
- Emergency measures to both expand supply and cut energy utilisation to ease the energy shortages and bring down prices.
- A reduction in VAT on energy and fuel bills, and any punitive green levies.
- Targeted cuts on imported foodstuff tariffs, particularly food not produced in the UK, whilst also working with supermarkets around reintroducing business rate relief for direct pass-through into lower food prices.
- Quickly make changes to the immigration rules for seasonal worker visas when pinch points emerge in the economy, especially for the food and logistics sectors, covering up to two years.
- Greater support for work through improving the taper rate within Universal Credit payments.
- Reversing Corporation Tax and NIC increases, as part of a plan for economic growth.
- Urgency is needed and people need to be reassured that the Government is taking this seriously, so COBRA or a similar mechanism should be used to coordinate the response.
Dr Clive Black, Vice Chairman
Matthew Elliott, Senior Political Advisor