Politicians are always keen to tell us either how marvellous things are now or, alternatively, how marvellous things will be once they have their hands on the levers of power. From Gordon Brown’s “no more boom and bust” through to Boris Johnson’s “build back better”, our political leaders tend to lack humility when it comes to delivering economic progress. They’re not so good, however, when the economy takes a turn for the worse.
That, unfortunately, is where we now appear to be heading. Ahead of next week’s Spring Statement, Rushi Sunak has been having economic history lessons, trying to get to grips with the 1973 oil price shock. It’s a sensible move. The UK’s reaction to the quadrupling of oil prices that year was one of the worst among the world’s industrial nations. Both inflation and unemployment surged, leading to a far more extreme version of “stagflation” than elsewhere. Britain became known as the “sick man of Europe”.
Why did things go so wrong? Partly, it was a refusal to admit that higher oil prices had made people in the UK worse off. Policymakers rightly realised that rising energy prices would leave people with less to spend on everything else. They wrongly concluded that this “loss” could be offset with a bit of monetary and fiscal stimulus. Remarkably enough, interest rates were regularly cut through 1974 even as inflation continued to build, peaking at a staggering 26.9 per cent in August 1975. Sterling collapsed. Unemployment headed far above 1 million.
In effect, UK policymakers had helped unleash a perfect storm. They refused to accept that inflation reflected their own policy errors, even though inflation had been heading higher long before the oil shock. They regarded the oil shock itself as something that could be “fixed” via a few policy tweaks. They couldn’t bring themselves to admit that events taking place “over there” required people to accept diminished living standards “over here”. Inflation was the mechanism by which this unfortunate new reality was imposed. Some suffered more than others. Those with cash savings or with fixed cash incomes – notably, pensioners – were particularly hard hit.
Will Sunak be brave enough to spell out the likely implications for the British public this time round? Will the Bank of England – no longer being told by the Treasury what to do, as had been the case back in the 1970s – act to squeeze inflation out of the system?
Ahead of Sunak’s update, much of the discussion has focused on what more can be done to insulate people from higher fuel prices and, separately, whether now is the time to raise National Insurance contributions. Additionally, Labour have pushed for a windfall tax on energy companies.
All important stuff, of course, but in the grand scheme of things, much of this may only amount to tinkering at the edges. We cannot know for sure where energy prices will eventually end up – who knows the extent to which Vladimir Putin will choose to reduce the flow of gas from Russia into Europe? – but we can be sure that, as energy prices rise, income is being redistributed from energy consuming nations like the UK towards the world’s energy producers. Our impoverishment is, at the same time, their windfall gain.
If Boris Johnson is indeed heading out to Saudi Arabia in a bid to persuade the Gulf to pump out more oil, thus reducing Europe’s Russian energy dependency, it’s just possible that some of the most recent energy price pressures will ease. After all, higher energy prices are a double-edged sword for oil producers contemplating an eventual “net zero” world. Near-term riches threaten to reduce the pressure for reforms necessary to build that post-oil future.
Still, relying on the goodwill of the energy producers won’t be enough, on its own, to stabilise the UK economy. More needs to be done, not least in dealing with an inflation problem which was steadily getting worse long before Putin decided to invade Ukraine. The Bank of England will probably raise interest rates a notch further on Thursday, with Bank Rate maybe rising to 0.75 per cent. Yet with inflation already running at 5.5 per cent and set to go a lot higher in coming months, this level of interest rates can hardly be described as bracing.
It's another way of saying that, when the economy takes a turn for the worse, the choices available are typically all horrible. For policymakers, however, choices nevertheless have to be made. As Ben Affleck’s character put it in Argo, “There are only bad options….it’s about finding the best one”.
