The UK lacks a clear plan for fighting inflation

Growth in the UK is projected to be lower than its peers in the coming years, and inflation is expected to be higher and more persistent. But I think it is worth looking at an underpriced risk: that a muddled government response might accidentally set the already-ruined British state ablaze because ministers lack a clear sense of macroeconomic structure.

Last month, Boris Johnson, still the prime minister, told reporters that railway workers were expecting too much when they asked for a pay rise of 7 per cent — this is less than the current inflation rate of 9.4 per cent. “Too high demands on pay will make it incredibly difficult to bring to an end the current challenges facing families around the world with rising costs of living,” he said.

These sentiments have been echoed by ministers since — and seem to be something they say in private, too. Andrew Bailey, the governor of the Bank of England, has called for pay restraint all around. But using the public sector pay frameworks (which recommend how pay should be set for public employees) and public budgets (which allow those pay levels to be delivered) as a tool for helping to steer the price level would be a huge change to the UK’s policy norms.

Britain uses monetary policy to target inflation; it has been decades since we had a so-called incomes policy to fight inflation. Indeed, the pay review bodies, panels that advise ministers on public pay levels, are only asked to consider how best to run the services. For example, the review panel for teachers has a mandate “to promote recruitment and retention, within the bounds of affordability across the school system as a whole”. It is not asked to think about other wage-setters.

​It’s not unreasonable to think that public sector pay settlements could be used as benchmarks for other employers. But if you try to use the single public sector pay instrument to target both public sector retention and inflation, you will end up missing at least one of them. And, right now, it is almost certainly going to be retention that suffers.

After 12 years of squeezing, Britain simply has no room to use public sector budgets as anti-inflationary ballast. Take the NHS, where 6.6mn people in England are on a waiting list. That’s well over 10 per cent of the country. My colleague John Burn-Murdoch has already written that it is possible that NHS performance means a large number of people are struggling to return to work after the pandemic.

There is a crisis brewing here. The kindest word I can think of to describe the government’s plans to attack the waiting list is “flaky”; parts of the hospital system have not yet recovered to even their pre-pandemic levels of performance, let alone to a pace where they can start burning off the care backlog.

Things are likely to get worse — and become a political problem, too. Take this much-watched measure, once the key target of NHS performance, of how many patients are dealt with within four hours of arriving at an emergency department. Things are already dismal — and will get worse as the weather turns.

In addition to a short-term problem, there is a long-term one. NHS pay (and the training pipeline) is already well out of line with what is needed to fill jobs: nurses’ pay has dropped by about 10 per cent over the past decade. The Nuffield Trust, a think-tank, reckons England is short of 12,000 hospital doctors and 50,000 nurses. A recent parliamentary committee report noted that there are 200,000 vacancies across the health and social care system.

It is hard to see how the existing headcount can cope with the ever-rising demand for healthcare. Most of the low-hanging efficiencies that can be wrung out of the English NHS without upfront spending have been exploited. For example, according to the Health Foundation, the average time in hospital for admitted patients is down by 22 per cent since 2010. But that is done. There is no more slack to give. From here on, squeezes in budgets are going to turn into poorer services.

A similar story can be told about much of the state. Schoolteachers, too, are hard to find; I have spotted one local school near my home in south London dipping below the legal minimum number of 190 days a year open. Local government, which offers services from bin collection to social care, is crippled. There are parts of the state which are now falling over, and which cannot absorb new real-terms cuts.

So what do you do, facing this, if you are worried about inflation and growth? Well, go back to first principles:

  • Set pay to fill jobs

  • Set service budgets to buy what you need within your fiscal rules

  • Set taxes to get the fiscal position roughly in balance over the medium term

  • Set benefit rates to shield lower-income households from the horrific increase in prices

  • Set monetary policy into gear to control inflation

This is a classical macroeconomic framework — the sort of thing that might have been proposed by Jan Tinbergen, the late, great Dutch economist. Work out what your targets are and then make sure you have at least one instrument aimed at each of them.

These instruments pull against one another: I am outlining a proposal to borrow a chunk of cash, spend it, raise wages and then let the Bank of England lean harder into demand with tighter monetary policy. This could well lead to a longer period of higher-than-comfortable inflation. But this is an orderly macroeconomic structure — one that will hold together. You know how the parts will shuffle and move as the facts change.

By contrast, trying to take a tough line on inflation using public services as a counter-inflationary weapon runs the risk that ministers end up losing control anyway, then folding wastefully into bailing out public services and energy-shocked families in a panic a few months hence. Indeed, a “stand tough” framework is one that will struggle more if inflation surprises to the upside. It is likely to disintegrate under political pressure as real household incomes, hospital performance and school hours sink.

The shift in the terms of trade since the war in Ukraine started has made the UK poorer, and Britain needs to allocate the losses. But squeezing public budgets means asking the same public workers who have taken the hit since 2010 to take it again. And, given the lack of slack in the state and goodwill among those staff, that certainly means cutting services too. At root, this truly is one of the oddest of macroeconomic ideas: using hospital admissions and the length of the school day as an instrument to target the inflation rate.

Martin Sandbu is away. Claire Jones will be back next week.

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