How can we tame the inflation tiger?

By Harry Fone, grassroots at the TaxPayers’ Alliance


For most of my lifetime I’ve never had to worry about rising inflation. Until fairly recently, inflation has never been higher than 4 per cent since 1993. When New Labour made the Bank of England (BoE) independent in 1997, it felt like it would never be a pressing concern again. The government set the BoE a target that inflation should not exceed 2 per cent. If it failed, the bank’s governor had to explain in writing exactly what had gone wrong. 


Fast forward to 2022, and we can only dream of “low and stable inflation”. This morning’s figures put the Consumer Prices Index (CPI) at 7 per cent for March. There are mounting fears that will soon surpass 10 per cent. Indeed the Bank’s chief economist, Andy Haldane, gave a speech last year called, “Inflation: a tiger by the tail?” In it, he outlined his fear that keeping inflation under control could be much harder than many policymakers expect. Concerns that would have been unthinkable a decade ago. So what can be done to rein in inflation?


It’s worth pointing out that inflation occurs because of an increase in the supply of money, which is largely governed by interest rates. In simple terms, lowering the interest rate will increase the amount of money and vice versa. When there’s more money in the economy, prices increase and consequently, inflation occurs. Are we now paying the price for a decade of historically low interest rates, and is it time to hike them up again?


The answer would seem to be “yes” to both questions. Since February 2009, the interest rate has not passed above 1 per cent; hitting a low of 0.1 per cent in March 2020. It’s been incredibly cheap to borrow money, and with the addition of quantitative easing, Britain’s money supply has expanded rapidly. It’s no wonder that the Bank of England has imposed two month-on-month interest rate rises to 0.75 per cent. More increases aren’t being ruled out.


The last time Britain faced dangerously high inflation was in the mid-70s, when it peaked at 24.2 per cent. It wasn’t until 1986 that it dipped under 4 per cent - for the first time since 1967. So how did the governments of the time wrestle inflation under control?


For the most part, they did so by increasing already relatively high interest rates. Before inflation peaked, interest rates were sitting at around 6 per cent in the early 70s. By 1974 they had doubled to over 12 per cent, and nearly tripled to 17 per cent in 1979. Interest rates didn’t get back into single figures until 1982, and even then it was still 9.63 per cent. It wasn’t just high interest rates that helped tackle inflation - the Thatcher government reining in the size of the state had a vital role to play too. 


But while hiking interest rates can help curb inflation, it has a profound effect on millions of households across the country. Homeowners on variable-rate mortgages will already have seen their monthly payments increasing. Further interest rate rises will only add more strain, particularly at a time when real wage growth is stalling. Students are also affected too. Analysis by the Institute for Fiscal Studies found “that the maximum interest rate, which is charged to current students and graduates earning more than £49,130, will rise from its current level of 4.5% to an eye-watering 12%.”


It also discourages investment as entrepreneurs have to pay higher prices for borrowing money, and households have less disposable income thanks to higher mortgage payments. People with savings (and no mortgages or loans) tend to benefit most from higher interest rates. But that is assuming that interest rates are higher, or as high as inflation.


There aren’t many that gain from a higher interest rate, and things are no better at the macroeconomic level either. The latest figures from the Office for National Statistics (ONS) show that central government current (or day-to-day) expenditure was £73.2 billion in February 2022, £1.0 billion more than in February last year. Of this, debt interest payments were £8.2 billion, a £2.8 billion increase from the year before.


High inflation is damaging to the economy - just ask anyone in Venezuela how bad the effects are. If inflation doesn’t start to fall soon then interest rates will likely increase, further exacerbating the cost of living crisis. The government must carefully navigate these stormy waters and ensure its economic policies don’t sink the ship. Taming the tiger isn’t easy but getting public spending under control is a great place to start. Eradicating billions of pounds of waste would ease the 70-year high tax burden on Brits and help to calm the current crisis. If Rishi Sunak and the Treasury need a helping hand, there are plenty of places they can start trimming the fat.

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