Liam Fox: The Bank of England raised interest rates too slowly. Now it must be wary of raising them too quickly.

18 May

The Rt Hon Dr Liam Fox MP is MP for North Somerset and a former Defence and International Trade Secretary. 

For many younger people in Britain, inflation is a new and startling experience, something they had previously only heard of in history books. For many of us, it was a formative personal and political force, one of the main reasons why many of us embraced Thatcherite Conservatism and its emphasis on “sound money.” Nothing undermines the stability of our economy, communities, and families more than inflation. It inevitably hits the poorest in society hardest and shifts money away from those who have saved for a rainy day. It is both a moral and economic hazard.

In the 1970s, I remember our family having to make cutbacks (including switching off the central heating we had only recently acquired) as inflation outstripped my father’s income. In the 1980s, I bought my first flat just as the Lawson boom hit. As a junior doctor, I soon found almost my entire income taken up by my mortgage as interest rates surged to 14.88% by the end of 1989.

Today, we are witnessing a return to global inflation, although at widely different levels. It is probably more accurate to say that we are witnessing two types of inflationary surges simultaneously. The first results from the supply disruptions that accompanied the Covid 19 pandemic with a mismatch of supply and demand in commodities and an interruption of global supply chains. The second is what we might describe as the monetary inflation that afflicts those countries whose central banks have allowed persistent increases in the amount of money relative to existing output.

As the pandemic took hold, central banks adopted policies of quantitative easing (QE) but at hugely differing rates. QE results in the purchase of large quantities of assets, such as government bonds, with the aim of supporting economic growth, lowering the cost of borrowing and boosting spending. Designed to have an anti-deflationary effect, too much can result in dangerously high inflation.

According to the Atlantic Council’s Global QE Tracker, in the United States the Fed began purchasing assets during the pandemic at an average rate of $120 billion per month. Since early 2020, these purchases have grown the Fed’s balance sheet by more than 114 percent.

In Britain, the Bank of England (BoE) put in place a QE program of support worth £895 billion to support the UK economy and financial market functioning. The bank’s asset purchases have increased the size of the balance sheet by more than 100 percent since the beginning of the pandemic.

The European Central Bank’s (ECB) pandemic emergency purchase program (PEPP) complements its Asset Purchase Programme (APP). Together, both QE programs have increased the size of the balance sheet by 88 percent since the start of the pandemic.

Meanwhile, in Asia, the Bank of Japan committed $874 billion to support the economy and the functioning of financial markets. These new asset purchases, together with the bank’s increased lending facilities, have increased the size of the balance sheet by a much smaller 17%. The latest inflation figures show the United States at 8.3%, the Eurozone at 7.5%, the UK 7%, and Japan 1.2%.

As the World Bank has noted, “The primary drivers of the inflation spike are not uniform across countries, particularly when comparing AEs and EMDEs. Diagnoses of “overheating,” prevalent in the US discourse, do not apply to many EMDEs, where fiscal and monetary stimulus in response to COVID-19 was limited… Inflation thus has become a global problem – or nearly so, with Asia so far immune.”

So, what about the British experience? Since 1997 the Bank of England has had operational independence for the conduct of monetary policy. The objectives of policy are set by the government while interest-rate decisions are the responsibility of the monetary policy committee. In November 1998, John Vickers, the Executive Director and Chief Economist at the Bank of England, set out the position with great clarity in a speech in Frankfurt.

He said “the paramount statutory duty of the MPC is the maintenance of price stability… The remit recognises that exogenous shocks and disturbances may cause inflation on occasions to deviate from the target, and that ‘attempts to keep inflation at the inflation target in these circumstances may cause undesirable volatility in output’. Most importantly, to me, is that he pointed out that “Subject to the paramount statutory duty of price stability, the MPC must support the Government’s economic policy, including its objectives for growth and employment.”

In other words, while the aims for employment and growth were important and laudable, they were required always to be secondary to the aim of price stability. How has this played out in recent times?

In a speech in November 2020, on the subject of climate change, Andrew Bailey, the Governor of the Bank of England said that: “We decided in the spring to prioritise preserving people’s jobs and livelihoods in this emergency, and as far as possible the businesses that provide employment and the life blood of the economy”. While this is understandable, and in line with the political priorities of the time, it is not putting monetary and price stability at the heart of the bank’s agenda.

In the same speech, the governor also said: “The financial system has supported the real economy in the crisis, as it must. We need that same ambition in our approach to climate change.” While we all support a concerted approach to climate change, there is a distinct feeling that those who should be protecting us from the debasement of our currency, the erosion of our earnings, and the devaluation of our savings have had their minds too much on a political rather than a monetary agenda.

The risk now is that having come late to the inflationary party – and consistently underestimated the nature and scale of the threat despite numerous warnings – the central bankers will overreact. With record amounts of assets on their balance sheets they may move quickly from quantitative easing to quantitative tightening.

While this will reduce the amount of money in the economy and counter inflation, the risk is that they will overcompensate, resulting in recession. This could produce further disruption in the developing economies with potential political disruption and the risk of debt default. This risk is exacerbated by the war in Ukraine and continued supply chain disruption.

No one believes that the policy decisions that need to be taken will be easy, but we deserve central banks who keep their focus on their day job, that of monetary stability.

Gerard Lyons: Ministers have an opportunity to cut taxes, drive supply side reform – and help reduce the cost of living

17 May

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

“My Government’s priority is to grow and strengthen the economy and help ease the cost of living for families.” These opening two lines of the Queen’s Speech provided a powerful message.

Further action is needed to address the cost of living crisis. Also, those affected are not just families, but the vast bulk of households that are being squeezed. If the Government doesn’t appreciate this, then it may have its work cut out.

To its credit, the Government has already announced a host of targeted measures. These include a £150 refund on council tax for those in bands A to D. While welcome, the gains are partially offset by a rise in the average Council Tax in band D of £67.

The main help by far, though, was announced by the Chancellor in the Spring Statement – an increase in the threshold at which the higher rate of national insurance is to be paid. This has now been aligned with the starting threshold for income tax, around £242 per week. There is also the expectation that the Government will act again, as energy bills are expected to rise again this autumn, when the new price cap kicks-in.

Indeed, the cost of living crisis looks set to get worse, before it gets better. UK inflation is set to peak soon, probably above 10 per cent, and will then stay elevated for some time. While inflation is set to decelerate next year, it seems unlikely to return to its two per cent target anytime soon.

It also vital to appreciate that we are very quickly moving away from the main problem being inflation to it being a lack of economic growth. There thus needs to be a reiteration of a clear, executable vision and strategy to grow and strengthen the economy. But first, the cost of living crisis merits further attention.

High fuel and food prices are already exacerbating problems for lower income households, who spend a higher proportion of their income on these areas. At the same time, a large part of peoples’ disposable incomes fund their housing costs. Furthermore, as the retail price index heads higher, rail fares will rise, and changes earlier this year added to the cost of repaying student loans.

While some have savings they can dip into, many don’t. Thus, overall, discretionary spending will be squeezed with widespread negative consequences for retailers and many firms. In turn, there will be upward pressure on costs, prices and wages.

Even the labour market, where unemployment is low, could see change since a sharp economic slowdown is likely, including the possibility of a technical recession with two successive negative quarters of economic growth.

The challenge is that, surely, the Government can’t go on spending taxpayers’ money at every sign of trouble? That is right – but downside economic risks mean intervention is needed, not only to ease the burden but also through low taxes to revitalise growth. The situation also highlights the need to restore both fiscal and monetary stability, once the economy allows, allowing scope to cope with future shocks.

The economic and political shock-absorber is a looser fiscal policy over the next year. Although the budget deficit is higher than one would like, the good news is that it is falling sharply: from £317.8 billion in 2020/21 to £151.8 billion in 2021/22, and is expected by the Office for Budget Responsibility to decline further to £127.8 billion in 2022/23. Moreover, higher inflation is already bolstering tax receipts.

So what should be done? Relaxing fiscal policy and targeted support should not add to inflation since demand is already slowing. Targeted help is needed for those on low incomes, but also there is a need to help the squeezed middle.

Other countries have enacted policies to shield people from rising energy prices, including reduced taxes on energy or VAT; retail price regulation; wholesale price regulation; transfers to vulnerable groups; mandating firms’ behaviour; windfall profits tax; business support; or other measures (such as cutting the green levy in Germany).

While other countries, too, are tightening monetary policy, the UK is unusual in that it is squeezing fiscal policy. Benefits, for instance, were not raised in line with higher inflation in the Spring Statement, when perhaps they should have been. Crucially, the tax take is at an all-time high. The latter needs to be reversed. It includes too many people being dragged into higher tax brackets, and this can only be addressed by raising tax allowances and the levels at which people enter higher tax bands.

Quickly executable targeted measures could include a further increase in the Council Tax rebate. Another would be to use Universal Credit to direct more money to those in most need, while preserving work incentives. A mid-year rerating of benefits to raise them in line with higher inflation may take longer to implement but is another option

Temporary removal of some of the permanent components of fuel duties should be considered although, like many of these measures, further cuts in taxes on energy are not cheap. The temporary five pence cut in fuel duty is set to cost £2.4 billion this fiscal year. Suspending VAT on domestic energy while gas prices remain high has been suggested by some MPs.

Another possible but unlikely option is a temporary suspension of the environmental levy paid on energy bills. It would not, in my view, compromise the Government’s commitment to the green agenda, and could free up about £340 per household per year. The importance of addressing climate change is critical; it is peoples’ ability to pay that is the issue.

There is a clear case for bringing forward the one pence cut in income tax that has been pencilled in for before the next election. The Treasury calculates that this will costs £5.4 billion in its first year, but it would address an important issue in that income tax collection is now heavily concentrated, with roughly four in ten adults only paying it. A broader tax base with low tax rates makes more sense, but that may be a future aim.

There is also a search for non-fiscal measures that can help businesses and households. Measures that both ease the burden on firms and employers, while bolstering their confidence about the future, should figure prominently.

The most obvious is to implement supply-side measures from the Taskforce on Innovation and Growth Report. Although some may take time to feed through, they should bolster business confidence and encourage investment.

Also, measures to turbo-charge the housing market are welcome. Planning reform, while necessary, appears to have taken a back burner. A year ago, in a research paper for Policy Exchange, I outlined measures on the demand side that could help Generation Rent become Generation Buy, including allowing those who cannot afford deposits to use their history of regular rent payment to enter the housing market.

If the economic climate deteriorates, banks should be encouraged to exercise forbearance on loans if firms encounter difficulty. The Bank of England should also re-examine prudential requirements to ensure that these are not having a negative impact on growth.

This proactive policy response to address immediate challenges is complimentary to other areas of policy. It should not threaten the inflation outlook. Crucially, it is consistent with the existing fiscal strategy of reducing the ratio of debt to GDP from its present level of 96.2 per cent and the aim to achieve a significant improvement in the public finances. Strengthening the economy is the aim, easing the cost of living crisis is the immediate focus.

The threat to the rule of law from left and right

16 May

How parochial our Bill of Rights is compared to the sweeping, modern constitution of Russia. “The pretended Power of Suspending of Laws or the Execution of Laws by Regall Authority without Consent of Parlyament is illegall,” says the first, taking the reader to the vanished world of the late seventeenth century.

“Fundamental human rights and freedoms are inalienable and shall be enjoyed by everyone since the day of birth,” declares the second: a statement of the obvious in any progressive, liberal democracy.

I draw the contrast, with all its savage irony, to make a point: that the rule of law is guaranteed not by words on paper, but on what people do – on their institutions and culture they create.

The thought applies to the Government and the rule of law.  We know the charge against it: that not so long ago, the challenge to the rule of law came from the left, and that now it comes from the right.

And that it covers everything from the prorogation dispute in the last Parliament, to parties in Downing Street and the threat to break international law in this one.

David Gauke has made a case for this view on this site and Daniel Hannan a case against.  I want to open my own take by conceding Boris Johnson’s weaknesses.

Most politicians pride themselves as being on top of the facts.  Though the Prime Minister can do facts as well as anyone when he puts the work in, the truth is that they bore him.

On the canvas he paints upon, the dazzling colours of hyperbole and metaphor count for much more than the black and white drudgery of facts.

Being fired for making up a quote, pyramids of piffle, late declarations of interest: given the background and his temperament, it’s not surprising that he has become the first Prime Minister to have been fined for breaking the law.

Which makes it all the more important to understand how he comes to hold the post with such a large majority.  Let’s go back for a moment to a turning point in the story: prorogation.

In 2019, John Bercow, then Speaker, made a ruling on proceedings about Brexit against the advice of the then Clerk of the House of Commons, Sir David Natzler, and in defiance of convention, as Bercow himself admitted.

His decision paved the way for Dominic Grieve, Yvette Cooper, Oliver Letwin, Hillary Benn, Nick Boles and company taking control of the Order Paper and the Commons.

Focus for a moment not on what they did, and its rights and wrongs, but how it came about.  Bercow was illustrating my point about how the rule of law is sustained or compromised.

There are few constraints on the Speaker of the Commons precisely because it is assumed that they won’t be needed.

By voting Bercow into office and propping him up, Labour and other MPs lit a constitutional fire.  And it is Dominic Cummings’ way to fight fire with fire.

So the prorogation plan was devised.  Which takes us to the Supreme Court’s ruling that discontinuing the session was unlawful.  Again, I ask you not to take a view on the judgement, but to consider the background.

The Court could have taken the view expressed previously by the Lord Chief Justice – that the prorogation was “inherently political in nature and there are no legal standards against which to [its] legitimacy.”

That it did not reflects a change that has taken place in the courts over the past quarter of a century or so – what Policy Exchange calls the growth of judicial power.

In simple terms, this places a higher premium on universal rights and a lower one on British particulars than was once the case.

Perhaps this was always likely to be so given the Human Rights Act, the development of the European Court of Human Rights, and the effect on the courts of almost 50 years of EU membership.

There may come a time when right and left swap sides on judicial power.  I can imagine a Labour Government governing, as the last one did, with scant regard for individual freedom.

Remember Tony Blair’s plan to detain terror suspects without trial for three months.  In similar circumstances, I can imagine Conservatives reaching for the Human Rights Act and the European Court.

The point I’m making reaches beyond party politics: namely, that the shift that has taken place within “the academy”, as the nexus of senior judges and legal academics is called, about the nature of law in Britain has big implications.

Only a minority seems to believe that, ultimately, Parliament is no longer sovereign: that in the last resort there are certain fundamentals that MPs have no authority to breach through legislation.

But the spectre of “conceptual overreach”, as the impeccably moderate Robert Buckland called it, was real enough to spook him as Lord Chancellor.

He wanted to restore “the very conventional thinking that Parliament makes laws that give power to the executive and are checked by the judiciary”.

So, then: a Speaker who didn’t play by the rules, and judges with an activist take on law.  Now we move from the courts, and the shift in power from elected to unelected, to other arenas.

Sometimes, such changes are for the best, or so it seems.  Consider Gordon Brown’s decision to declare the Bank of England independent, for example.

At the time, he was applauded for curbing the power of politicians to debauch the currency.  Today, the Bank itself is accused of doing exactly that.

You don’t have to believe that Brown’s decision was wrong, at least in principle, to believe that the accrual of power by unelected people raises questions of accountability.

These are multiplied when those responsible for regulating government and Parliament overlap.  And gain the power to police MPs for flouting “anti-racism, inclusion and diversity”, as is proposed.

Or when the police themselves choose to fine – or not to fine – politicians without explaining why, with potentially momentous consequences.

A literal view of the rule of law would be that Johnson or others are only in breach of it if and when they are found to be so by the courts.

I am taking a broader one which argues that the rule of law is compromised by people of all parties and none as much when Speakers break with convention as when Ministers are fined.

As it would be were the consensus about the neutrality of the courts and the impartiality of regulators to break down. We are not America yet, but it could happen.

There, the threat is anarchy – a Left that wants the police defunded and a Right that cries foul when it loses elections.  In Russia, the reality is what follows the breakdown of order: tyranny.

In short, the British consensus about the rule of law is under strain. The Government has a problem with it in the sense that a man has a problem if he catches Covid.  He may recover quickly, and he may not.

Yes, he can make his and others’ condition worse by behaving irresponsibly.  But there is no point in berating the patient without also seeking to understand the illness. It strikes down Speakers when they break rules.

Judges display symptoms if they deny Parliamentary sovereignty. Regulators risk catching it if they grab for more power.  Like Covid, threats to the rule of law are social.  They spread.  There is reaction and counter-reaction.  It is a more profound challenge than most of Johnson’s critics want to understand.

Gerry Lyons: How the Bank of England has failed to control inflation. And what should be done to reform it.

3 May

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

This week sees the Bank of England celebrate 25 years of independence. Quite rightly, the current rise in inflation has raised questions about whether it is time to reassess its remit and governance.

There has been a rise in inflation across western economies. That this is more than a UK issue should not divert attention from where the problem lies.

If you are driving a car and approach a red light and decide to not only ignore the signal to stop but put your foot down on the accelerator, you are driving dangerously. That some other cars may do the same does not change that fact. It is not safety in numbers, but is more likely to cause greater carnage. Last year, in monetary policy terms, central banks went through the red light – with their feet down on the accelerator. The Bank of England was near the front.

At that time, it was clear that our economy was recovering and inflationary pressures building. The supply-side shock triggered by the pandemic was already evident. The correct policy would have been to tighten policy, not add fuel to the fire by increasing Quantitative Easing to a mammoth £895 billion.

The question I posed then was: which ‘p’ was this inflation? Would it pass-through, persist or become permanent. The Bank strongly believed it would pass through quickly. It was evident it would persist. It was unlikely to be permanent because of intense global competition but, even if inflation persists, once it then eases it may settle at a higher level than before, say nearer three per cent to four per cent than one per cent to two per cent.

The danger, as was clear at the time, was that even if the initial cause of inflation is a supply-side shock, action needed to be taken to prevent cost-push inflation by which firms raise prices to pass on higher costs, or second-round effects allowing prices and inflation expectations to creep higher. Effective communication as well as clear actions were called for. We got neither.

What are the lessons and implications?

Consider the 1970s. It may be hard to believe, but Britain began the 1970s as the low inflation country of Europe. Monday 15th February 1971 was Decimalisation Day, when we moved from 240 pennies in the pound to 100 new pence.

Ahead of that day, I remember paying my bus fare with pennies that had been minted not just in the early part of the twentieth century but some in the nineteenth century too, with Queen Victoria’s head on them. That such old coins were still legal tender was testimony to how well Britain had kept inflation under control.

Apart from the First World War, when annual inflation averaged 15.3 per cent in the UK, only the 1970s saw high inflation, averaging an annual 12.5 per cent during that decade. There is no reason why, with the right policies we cannot return to being a low inflation economy.

The 1970s showed that inflation is deadly. That’s why the complacency with which the Bank treated it last year was wrong. It is felt by everyone, with the poor and those on fixed incomes like pensioners suffering the most.

Another lesson is that the measures necessary to control inflation are deeply uncomfortable, often requiring sharply higher rates, with damaging economic consequences. Nowadays, with borrowing higher, the economy is not only vulnerable to higher rates, but can be impacted sooner as policy tightens.

UK policy rates are currently only 0.75 per cent, while annual consumer price inflation in March was seven per cent, ten times higher than its rate of 0.7 per cent a year ago. And it will head higher.

Harold Wilson, Edward Heath and Jim Callaghan all lost elections because of their inability to control inflation. A central feature of the two general election campaigns in 1974, and even of that of 1979, was the use of a shopping basket to show how the Government had failed. Don’t be in any doubt as to who pays the price for a failure to control inflation.

Given this background, and how important monetary policy is in everyday life, one might think Westminster would pay more attention to the Bank of England – to how it is governed and keeping inflation under control. It is now as the cost-of-living crisis bites and the economy slows sharply.

The weekend saw much coverage of the 25th anniversary of the Blair landslide in 1997. An early decision – on 6th May 1997 – was to award operational independence to the Bank of England.

Although a surprise – having not been mentioned in the campaign – independence had been a topic of discussion for some time among economists. Indeed, I remember a well-attended Society of Business Economists debate early in 1997 where David Currie gave the case for central bank independence and I argued against. There were pros and cons. It would embed low inflation expectations, but there was a need for transparency and democratic accountability.

Even the Bank’s own Quarterly Bulletin in 1995 had carried an article by a leading economist, Robert Barro, showing that it was not independence but often an external factor that was the driving force behind inflation. Indeed, China’s entry into the World Trade Organisation in 2001 contributed to intense competition – helping to drive inflation down globally and in the UK for much of this century.

Inflation has averaged two per cent over the last quarter century. While welcome, this should not divert attention from how the economy has suffered the consequences of three major policy mistakes from the Bank.

First, monetary policy has fed rampant asset price inflation, in financial markets and property. Alongside low property supply, this has fed intergenerational inequality.

Second, a cheap money policy through low interest rates and Quantitative Easing has fed financial instability as markets do not price properly for risk.

Third, the Bank’s recent policies have fed inflation.

Attention usually focuses on the Monetary Policy Committee and interest rates. Thus, the Bank’s other policy committees on prudential regulation and financial policy are too often freed from scrutiny – as is the interaction between these policies. The economy, after all, is significantly affected by the prudential controls placed upon on banks, and peoples’ ability to borrow has been impacted by micro-prudential regulations.

While the Bank, in recent years, has played a welcome role in how finance can help achieve the green agenda, there are other important areas that the Bank should confront. Not least among these is the low level of commercial lending to small firms. It should also be more of a cheerleader for the Square Mile.

Now, it is time to ask whether the Bank’s inflation targeting regime has run its course. I favour a new remit based on a target for nominal GDP. An anti-inflationary monetary policy remains critical, but change is well overdue.

In this much-needed review of the Bank there needs to be a reassessment of its governance, transparency and accountability.

The Bank’ governance is overseen by the Court, but this is rarely held to account, and would appear to pay only lip-service to diversity, not least in thought. Groupthink can be a problem with policymakers. In my view, one might ask if the Bank’s historic underrepresentation of those from working class backgrounds in senior positions hinders how it sees its policies affecting those on low incomes. Its communications too have caused problems. Yet, effective communication is critical – not only to the public and financial markets, but to global audiences too.

Gerard Lyons: Sunak should raise the lower tax threshold this autumn to put more money in people’s pockets.

5 Apr

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Higher inflation is inevitable. An economic slowdown is expected. Recession is possible. That is the economic outlook and challenge facing the UK. The question is whether policy makers are doing enough?

This troubling economic climate is not unique to us. All western economies are facing an imminent inflation challenge. And, alongside the war and its consequences, this is starting to weigh on confidence and growth prospects for later this year and next.

It was against this backdrop that the Chancellor delivered the Spring Statement two weeks ago. In many respects, it was a missed opportunity. While he cannot be blamed for higher inflation or fuel prices, and although there were some welcome measures, he has to accept some responsibility for the tax take continuing to rise and failing to increase benefits in line with inflation ahead of the cost-of-living crisis.

As expected, the Official for Budget Responsibility (OBR) projected a slowing economy over coming years and higher inflation before it subsides. After 7.5 per cent growth last year, growth is expected to slow to 3.8 per cent this year and 1.8 per cent next. Inflation, meanwhile, is expected by the OBR to rise from 2.6 per cent last year to an average of 7.4 per cent this, and then be four per cent next and 1.5 per cent in 2024.

Such an outlook – with the cost-of-living squeeze hitting people hard, and an economic slowdown ahead – added to the pressure for the Chancellor to do more to help.

Rishi Sunak stepped up to the plate during the pandemic, and perhaps the challenge from that is that it has created the impression that there is a bottomless pit of money into which he can dip. There isn’t.

Yet, as the Spring Statement showed, while debt is still historically high, the public finances are on an improving trend because of the strong rebound in the economy over the last year. This presented the Chancellor with ample room to act. Public borrowing was £321.9 billion in 2020-21 and is now expected to be £127.8 billion in the last fiscal year, 2021-22, which is £50.9 billion lower than the OBR forecast only last October.

But even last autumn it was clear that the finances were improvingm and at that time this cast doubt on the need to announce the increase in the national insurance. Moreover, the margin of error on these budget forecasts is high, suggesting the Chancellor should not feel bound by them when it comes to fiscal policy – especially for predictions several years into the future.

There is still much uncertainty about how resilient the economy will prove to be, as previous monetary policy stimulus is replaced by tightening, as the post-pandemic rebound loses momentum and as the cost-of-living squeeze bites. Measures of confidence have already started to deteriorate. The GfK measure of consumer confidence fell to its lowest level in sixteen months of -31 in March. This will likely get worse.

The biggest problem has been monetary policy and in this context the Chancellor should – at some stage – call for a fresh look at the Bank of England’s remit, operations and communication.

For more than a decade, the UK has suffered from a cheap money policy. This has had three damning consequences, each with economic and political implications.

First, it has fed rampant asset price inflation, not just in financial markets, but in property prices. This has fed inequality and inter-generational problems.

Second, the combination of low rates and the Bank’s buying of government debt through large-scale quantitative easing has contributed to financial market instability, with markets not pricing properly for risk.

Third, monetary policy has contributed to inflation. Even though the pandemic and supply shortages may have been a catalyst for rising inflation, the Bank’s complacency last year fed the problem. Moreover, it now means too that if the Bank has to tighten monetary policy, it will do so at a time when the economy is less able to cope.

With monetary policy having been too loose for too long, the uncertain economic climate might suggest the need for the Bank to tread carefully. It also added pressure on the Chancellor to do more.

Now, two weeks after the Statement, the dust has still not settled. In part, this is because there is increasing concern about what lies ahead economically, and whether the Government may be forced to act further.

The Treasury’s mindset is on balancing the budget – which they don’t do well – at the expense of economic growth. The prospect of slower future growth means more of the deficit is viewed as structural, not cyclical, necessitating fiscal caution. Furthermore, the fiscal rules which are aimed at making the fiscal numbers appear credible can end up embedding tax increases into future numbers to pay for spending plans.

Concern about the rise in debt service payments in the coming fiscal year also appeared to weigh on the Spring Statement’s plans. Perhaps this was overdone, with this rise explained by the increased cost of the principle of index-linked debt. This future liability counts as borrowing in the year in which it accrues, hence the spike in the next fiscal year which should not divert attention from the improving trend in the budget finances.

The Chancellor did unveil some significant and welcome targeted measures to cushion the pain. Most notably, increasing the National Insurance threshold, bringing it in line from July with income taxes at £12,570. This helped many people.

The other was the immediately fuel duty cut by five pence per litre until next spring – although this has not been fully passed on. This followed on from help announced before his Statement on council tax, fuel bills and changes to the universal credit taper rate. He also pre-announced a cut in income tax.

The alignment of national insurance and income tax allowances was a big deal. It not only helps simplify the tax system, but may be a stepping stone to abolishing national insurance completely. This is something many Chancellors have talked of, but none have done. This moves that closer.

Despite this, more should have been done and more help is now likely. This leads onto whether the Government is seen to be on the front foot, or are forced into acting. For instance, benefits could have been increased in line with the latest, higher inflation numbers. Also, recently announced changes to student loan repayments were unnecessary, and expensive for students, but bring in the Treasury sizeable revenues.

Looking ahead, there is still scope for the Government to cut taxes such as VAT on fuel, and shift green taxes from fuel bills onto general taxation (else they might be seen as a green poll tax, not linked to peoples’ ability to pay).

I would suggest raising the lower tax threshold this autumn, if not sooner, to put more money back into peoples’ pockets and to start to reduce the overall tax burden. Raising the upper tax threshold may be too expensive, or not politically acceptable.

Overall, the OBR reported that living standards are expected to fall by 2.2 per cent this coming year – the largest fall on record. And, despite the statement’s measures, previously announced policy measures and the more tax-rich composition of economic activity, the tax burden is set to rise to its highest since the late 1940’s, from 33 per cent of GDP in 2019/20 to 36.3 per cent in 2026/27.

Alleviating the cost-of-living crisis, keeping inflation in check and delivering stronger growth is the aim. This should be supported by smarter regulations and sensible taxes that lower the overall tax burden.

Gerard Lyons: Sunak’s task tomorrow. The best way of reducing the deficit is to go for growth.

22 Mar

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Rishi Sunak needs to provide context, actions and vision when he delivers his Spring Statement to the House of Commons this week.

Context, so that people can understand the present difficult economic environment and what lies ahead. Actions will be needed to cushion the imminent cost-of-living crisis. And the Chancellor needs to outline a vision, both from a domestic political perspective and to reassure financial markets and investors about the outlook for the economy.

The current context is a difficult one. The war in Ukraine and the associated high level of oil and commodity prices has added to uncertainty, both here in the UK and globally. This will be reflected in the economic forecasts from the Office for Budget Responsibility (OBR) that will accompany Sunak’s statement.

At the time of their previous forecast, last October, the OBR was forecasting growth of six per cent and inflation of four per cent this year. Now, depending upon their assumptions, the OBR’s growth forecast could be half and their inflation forecast almost twice as high as then. Hence the increased fear of stagflation – where inflation is higher, and growth lower.

For next year, the OBR will be expecting growth to slow further and inflation to ease. It is their cautious future growth outlook that limits the Chancellor’s room for fiscal manoeuvre. Sunak will also stress that higher inflation and interest rates increases the amount spent on servicing the national debt.

Despite this, the Chancellor should not feel constrained by the OBR’s forecasts into limiting the actions he can take. The margin of error for the budget deficit forecasts has been high in recent years – for obvious reasons, perhaps.

Importantly, the fiscal numbers, while poor, are clearly on an improving trend. During the first ten months of this fiscal year, public sector net debt was £138.5 billion, around half the level of a year earlier. So Sunak may have around £25 billion more to use in this statement than previously expected, and still be able to stick within his fiscal rules. He thus has the opportunity as well as the need to provide some help this week.

What then of the actions that can be taken? There are two areas he should focus on.

One is actions linked to the war, such as more immediate defence spending or help for refugees. The other is finding money to cushion the cost-of-living crisis.

While he may mention issues linked to levelling up and incentives to boost investment and improve skills, the bulk of tax changes and spending announcements linked to these will have to wait until the Budget in the autumn.

The imminent cost-of-living crisis is explained by higher inflation, rising fuel and energy bills, and increased taxes. The approach that the Chancellor is likely to take to address these is best captured by the three “t’s” – timely, temporary and targeted measures.

Even though people across all incomes, including the squeezed middle, are being impacted, help will be targeted to those on low incomes and most in need.

The rise in inflation is out of his control. But we shouldn’t pretend that no-one is to blame. Costs have risen across the board – initially because of supply disruptions triggered by the pandemic and now because of the war. At some stage these pressures will ease, but not yet.

But inflation has also risen because the Bank of England has been asleep at the wheel. Last year, when inflation was already rising, it printed an excessive amount of money as quantitative easing reached £895 billion. That made the inflation outlook worse, feeding inflation expectations.

The Chancellor can act on fuel duties. During the next fiscal year, fuel duties are expected to raise £28 billion. By comparison, income taxes will raise £229 billion and national insurance £182 billion. A bold step would be to suspend fuel duties completely for a period. But then the pain would be felt when reintroduced.

Indications are that fuel duty will be cut, perhaps for a temporary period. A similar approach has been seen recently in France and Ireland.

For example, take a litre of petrol at £1.65. This price includes fuel duty of 57.95 pence and VAT of 27.5 pence. So total tax is 85.45 pence

If fuel duty is reduced by five pence per litre, then, after taking into account VAT, this would reduce the price per litre by six pence, in this case from £1.65 to £1.59. A small but significant saving for many people.

A radical – but very unlikely – step would be to move environmental levies from fuel bills onto general taxation. From this April these levies on household energy bills will raise £9.2 billion over the fiscal year, around £325 per household per year. The importance of addressing climate change is critical, it is peoples’ ability to pay that is the issue. This leads onto the big issue that Sunak needs to address: taxes.

Two tax increases will bite this spring. There is fiscal drag: as pay creeps up it drags people into higher income tax brackets. Normally, this is addressed by allowing tax allowances to rise in line with inflation. Allowances have been frozen for a couple of years, so it is unlikely anything will change here.

The other tax is the increase in national insurance, which will rise for both workers and employers, and which comes into effect in a couple of weeks. For workers this rises from 12 per cent to 13.2 per cent, so someone earning £30,000 per year will pay £214 more and a £50,000 earner will pay £339 more.

In April 2023, this is replaced by a new health and social care level (which in all likelihood will rise in future years) and the national insurance rate falls back to 12 per cent.

There was no need for this tax to have been increased in the first place. It was already clear last autumn that the public finances were improving. Furthermore, it is a tax on jobs that it is coming into effect now when incomes are being squeezed.

Sunak appears keen not to reverse or delay this tax. Instead, he could raise the threshold at which national insurance is paid by workers. From April, national insurance is paid after you earn £190 per week. By contrast, the threshold for paying income tax is based on annual income but is equivalent to £242 per week.

The Chancellor also recently announced measures totalling around £9 billion to help people most in need. He could find other targeted help. For instance, benefits and allowances could be raised in line with latest inflation figures.

One lesson from following fiscal statements over the years is that, when it comes to chancellors, don’t just listen to what they say, watch what they do. During the pandemic, Sunak responded well. Further action is needed now.

Finally, despite uncertainty, it will be important for the Chancellor to outline a vision. The UK’s trend rate of growth is too low. The UK needs to become a more competitive economy. Sunak wants to reduce the budget deficit. That is understandable. His choices are: borrow, raise taxes, austerity via cutting spending, focus on boosting growth – or a combination of these.

Austerity is rightly ruled out, although public sector reform is needed. The trouble is that taxes are already high, even for people on modest incomes. The best way to reduce the deficit is to boost economic growth, allowing the ratio of debt to GDP to come down gradually, over time.

John Redwood: My critique of the Chancellor’s Mais Lecture, and what the Government should do next

7 Mar

Sir John Redwood is MP for Wokingham, and is a former Secretary of State for Wales.

Amidst all the harrowing reports from Ukraine and the deaths and destruction wrought there by Russia, the Chancellor has sought to chart a course for the economy for the next couple of years.

In his Mais lecture he echoed his predecessor, Philip Hammond, in seeking a productivity breakthrough. He also reaffirmed the Maastricht rules approach to economic management, wanting tax rises to get the deficit down first. The Treasury should note that its role model the EU has abandoned these rules for the time being, and is pursuing monetary and fiscal expansion.

The lecture was wrong to deny that lower tax rates can bring in more revenues. The Republic of Ireland has been a shining example of this, boosting its per capita GDP far higher than ours or the lower level of the  EU by attracting huge investments through a 12.5 per cent Corporation Tax rate.

Their business taxes offer a higher percentage of total tax take than our higher rates. The Chancellor ignores the findings of Margaret Thatcher and Nigel Lawson who he praises. They produced a surge in revenues from higher paid people by major cuts in income tax rates.

The Government should take the cost of living crisis more seriously. In accordance with the Mais lecture, it needs to create the conditions for private sector investment in creating more better-paid jobs and in producing more of the goods and services we need at home.

Levelling up needs to be private sector led, and offer people the chance to set up and run their own businesses, be trained for better paid employment, and find ladders of opportunity in the areas attracting the projects and businesses.

The Government should not take the fast growth rate of 2021 for granted. It was a one-off based on removing Covid restrictions and on an unprecedented injection of money by the Treasury and the Bank of England. In the end, they overdid it in scale and duration, triggering a nasty inflation. The new investment has to take place against a less supportive public sector background.

The rise of prices well above wages will cut growth, as people spend more of their money on such basics as food and energy. That will leave them with less to spend on leisure and pleasure – on items that are nice to have. The huge rise in energy bills alongside tax rises including National Insurance will sap spending power further. The economy will slow. The lecture did not tell us how the extra private sector investment will be attracted in these conditions, particularly with the planned rises in Corporation Tax to come.

These troubles will be compounded by the Government’s import promotion policies, which are most pronounced in the Business and Agriculture departments. Business is busy allowing the rundown of big energy using manufacture like steel, ceramics, aluminium, and glass in the name of Net Zero.

The trouble is that we then import the products from abroad, meaning that more C02 is created in their production and transport to us. The Business Department is busy reducing our oil and gas output so that we need to import more energy. Again, this adds to our CO2 production worldwide.The Environment Department is developing big subsidy incentives to remove land from food production and to encourage older farmers to give up. That will make us more dependent on imported food.

So why does the Government not like products made or grown at home? Why doesn’t it want more home output to boost jobs, incomes and lifestyles? Any sensible programme of levelling up should be cutting taxes and making it easier for local businesses and farms to set up and grow.

This year, revenues have come in much higher than the Budget forecast, thanks to higher growth – and way higher than the £12 billion that the Government says it needs for a tax rise. The Treasury did not put up rates of tax, so revenue grew. During the next financial year, higher tax rates and frozen starting levels will hit taxpayers hard. Revenue is likely to underperform as growth stutters.

An energy shortage is a big part of the problem. The government should ease the shortages of gas, oil and electricity. They should invite in the oil and gas producers in the U.K. and help them increase production straight away from current fields. They should offer licences for new production from all those new and extended fields that have already been discovered. That’s more jobs, better paid jobs, and plenty of extra tax revenue. It is also less CO2 generated globally, as our own gas produces under half the CO2 of imported LNG gas. We will have much more productive industry if we have cheap or competitive energy.

The Government should work with the electricity industry to keep the lights on. We  will need more capacity than is planned to cover the electric revolution. We need more power for when the wind does not blow and the sun does not shine. We should abandon the current policy of putting in more and more interconnectors to allow us to import more from an energy short continent.  They should produce schemes to promote more home-grown food.

John Redwood: Ministers must not led Treasury orthodoxy make a cost-of-living crisis worse

21 Feb

Sir John Redwood is MP for Wokingham, and is a former Secretary of State for Wales.

Let me have another go at explaining to the Government why they must remove the National Insurance tax rise, and cut VAT, before the full cost of living squeeze hits in April.

I have no wish to see the country damaged yet again by a foolish Treasury orthodoxy, aided by a Central Bank lurching from being too loose and inflationary to being too tough.

It is too late now to head off the round of inflation they have helped create. They both need to recognise that growth will  bring the deficit down and the belated ending of money printing will start to slow inflation after April/May without further action. The hit to real incomes ahead will also slow the economy.

I have seen Treasury theory do so much damage over my lifetime. I urged John Major not to push the UK into the inevitable boom bust that the European Exchange Rate Mechanism was bound to deliver. He went ahead, triggering an  inflation followed by a bust which collapsed house prices and took down many small businesses. It  cast the Conservatives out of office for 13 years.

I watched as Gordon Brown helped generate a Treasury orthodoxy that decided to correct a credit bubble they had created by a disastrous aggressive curtailment of cash and credit. This bankrupted large banks and brought on the predictable great recession. On the back of that, Labour have been out of office for 11 years so far.

Today inflation is too high. Tomorrow it will be higher, when the full energy price rises add to bills. Wage growth so far is below inflation. The cost of living squeeze will hit confidence and limit many people’s ability to spend on discretionary items, given the big rise  in the cost of the basics of food, energy and the mortgage.

Some say the inflation is the result of supply-side shortages brought on by Covid, international supply chain disruptions, and the general shortage of gas in Europe. Others point to the way the Bank of England continued creating extra money, buying up bonds, and keeping interest rates around zero long after the initial pandemic shutdown.

They were right to produce a strong positive response to offset the economic damage done by the health policies in 2020, but wrong to continue money printing in the later months of last year as recovery was well set.

Whichever explanation you prefer, it all points to a coming sharp decline in the pace of growth, a big reduction in consumer spending outside the basics, and a peak or surge in inflation. It does not look like a wage/price spiral setting in given the deflationary impact of the huge energy price rises and the consequences of the most severe advanced country monetary tightening on offer.

The Bank of England has stopped all money printing, has raised interest rates  and is even thinking of money shrinking whilst the ECB plans a further €40bn a month and the Bank of Japan carries on buying as many bonds as it takes to keep the ten year rate of interest near zero. Even the Fed, with a much bigger inflation problem than the others, is still unwisely printing more money this month. The Bank of England should give its tightening time to work before considering too much action.

The Treasury have one main argument against my proposal that we should cancel the extra National Insurance, end VAT on fuel, and cancel VAT on green products to make it cheaper to save energy at home: they say the deficit is too high so they need to hike taxes to reduce the amount we need to borrow.

I agree with them that the UK has to get the huge deficit down from the necessarily high levels to get us through lockdown. The Treasury said they could live with a deficit of £233.9bn this year. I thought that was too high, but also argued it was a very unlikely outcome in the  budget debate.

Now the Treasury thinks the deficit will come in at £183bn, £50bn lower. It is currently running more than £60bn lower with just three months more to report. In that case the Treasury on its own argument can easily afford to cancel the £12bn of National Insurance increase next year and forgo around £5bn of VAT revenue. It will still be reducing the deficit by a large amount compared with its assessment of what was realistic last March.

I have a strong economic reason why they need to do this. Why has the deficit fallen so much more than they thought this year? It is because the economy has grown more than they thought. It is also because the Treasury/OBR model of the economy underestimates just how much extra tax revenue they will collect if the economy grows faster.

By the same token, if they insist on slowing the economy too much this spring they will collect less tax revenue than they thought. They could end up with a bigger deficit from too tough a squeeze. If people spend less on non essentials because they are squeezed, there will be less VAT. There will also be fewer service sector jobs so less income tax. There will be less profits tax from non energy businesses.

I do not want the Government to fall for Treasury austerity economics again and plunge us into another slowdown – which will lead to more self defeating cries from the Treasury for higher taxes and lower spending. Of course we need to get inflation down. The Bank has now taken some necessary action to start to do that in the second half of this year.

The single biggest problem is the price of energy. The Government needs to get on with licencing and encouraging more domestic production of oil and gas, and more domestic capacity for reliable electricity supply. This is the way to address the chronic domestic shortage and to start to unwind the foolish dependence to sky-high priced imports from a continent even more short of energy than we are.

David Gauke: To cut taxes and raise spending would be unsustainable – and so fail to salvage the cost of living

14 Feb

David Gauke is a former Justice Secretary, and was an independent candidate in South-West Hertfordshire at the 2019 general election.

Last week, inflation in the US hit 7.5 per cent, the highest for nearly 40 years. In the UK, inflation is expected to hit seven per cent in the spring, the highest level since 1991.

There are clearly some temporary factors in play as the world economy returns to a new normality after two years of a pandemic causing major disruption. The transition will inevitably be bumpy and, the optimists argue, as long as we do not allow ourselves to assume that inflation is here to stay (which could result in a wage price spiral), high inflation should be a relatively short term phenomenon, as the spike in energy costs pass through the system.

The more pessimistic view is that there is a more fundamental over-heating of the economy. We have had years of quantitative easing and low interest rates, unemployment is remarkably low and labour shortages (caused predominantly by older workers retiring earlier) are likely to persist, and energy prices look set to remain high. We cannot assume, say the pessimists, that the current inflation is largely transitory. This latter view is gaining ground, including in the Monetary Policy Committee which has voted for two increases in interest rates in recent weeks, with a minority of members wanting to go further.

Whichever view is correct, inflation and its consequences will be the big domestic issue affecting people’s lives in the next few months. Most obviously, we will see a squeeze in living standards that is going to be very painful for many households.

The Bank of England is forecasting the weakest growth in real post-tax labour incomes in more than 70 years. This will have negative political implications for the Governmen,t with the local elections in May likely to be very difficult for the Conservatives, whoever is their leader at that point.

All of this will increase pressure on the Government to assist households facing higher costs. We have already seen an announcement of a loan scheme for energy costs, but there will be plenty of calls for more action, whether that is dropping or postponing the national insurance increases, cutting VAT on domestic fuel or increasing Universal Credit.

The Treasury will rightly worry about affordability and credibility. On affordability, the public finances are performing better than was predicted by the Office for Budget Responsibility at the time of last year’s October Budget, but the Chancellor will not want to get into the habit of spending all the proceeds of an improved forecast as a matter of course. Scrapping the National Insurance increase would also raise questions of credibility and suggest to the markets that the Government – with an 80 seat majority – is too weak to put up taxes. That is not a good signal to send.

A further problem is that if fiscal policy is being used to soften the consequences of inflation by putting more money into people’s pockets, the Bank of England might be compelled to move further and faster on interest rates. Mortgage holders may find that tax cuts are accompanied by interest rate rises.

The issue of pay rises is already proving to be contentious. The Governor of the Bank of England, Andrew Bailey, attracted criticism for his remarks that workers should not chase pay increases that match inflation.

These words – although well-intentioned – were unfortunate. Putting aside the inevitable criticism that he is in a position than most to afford a pay freeze, it could be interpreted that he was advocating a return to an incomes policy where the man in Whitehall (or, in this case, Threadneedle Street) told everyone else how much they should be paid. Private sector pay should be a matter for the market which can reflect changes in the labour supply and consumer choices.

Bailey was not really advocating a return to incomes policies, even though it sounded a little like that. His point was that large pay rises will make the process of getting inflation under control all the more painful with interest rates potentially having to go higher than would otherwise be the case and workers finding themselves priced out of a job. The higher cost of global commodities is going to have to be absorbed somewhere, and ultimately this will result in a fall in people’s real term income.

Pay rises in the public sector will be a contentious issue. Again, the issue is not really about controlling inflation (at least, only indirectly), but about the public finances. Big increases in public sector pay will place further pressure on spending and, understandably, the Chief Secretary to the Treasury, Simon Clarke, is calling for restraint. Controlling public spending, ensuring that public sector pay is sufficient to recruit, retain and motivate the workforce and avoiding a summer of disputes with the public sector unions will be no easy task.

There are measures that the Government can take to protect people from the squeeze in living standards, but the fundamental problem is that costs are going up faster than we are getting more productive. We can smooth the pain of a short term spike in energy costs – if that is what it is – but in the end these costs will have to be paid by real people, whether taxpayers or consumers.

If this all sounds somewhat fatalistic about the short term, that is true. Ultimately, our standard of living will be affected by factors such as global commodity prices as well as our own productivity. For multiple and complex reasons, many negative factors are coming to a head this spring.

The immediate focus of the debate will be distributional – who we should protect and how we should do it. Such a debate is understandable, and there is a very strong case for protecting the most vulnerable who will struggle to pay their bills.

But if the response to the cost of living pressures is cut taxes or spend more to protect the bulk of the population, we just end up borrowing more and passing on costs to future generations. Such an approach is unsustainable.

The reality is that our national living standards depend upon our success in delivering a highly productive, strong economy. Even in those circumstances, we will always be vulnerable to being buffeted by high commodity prices, but we are more exposed because of a relatively weak currency and low productivity growth.

The predictions made by the Prime Minister as recently as last autumn that we are about to enter a period of high wage growth now ring hollow as, in real terms, wages are falling. There is a risk that both the Government and Opposition focus their energies on short term solutions – often involving borrowing more money – without addressing the fundamentals.

Our living standards reflect the strength of the economy. It has faced a number of difficulties in recent years – some unavoidable, some self-inflicted – and this will have consequences. The challenge for policy-makers, about which we hear too little, is how we deliver that strong economy for the future.

Gerard Lyons: How to tackle the cost of living crisis

11 Jan

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

Crisis? What crisis? The good news is that the economic rebound continues, and the jobs market has returned to broad health. We may also be over the worst of the pandemic, although possible new variants mean that learning to live with Covid and avoiding further restrictions may be a key priority this year.

Yet it is not this recovery but two other economic matters that look set to dominate policy this year: the immediate cost of living crisis and, less talked about, where growth will settle post-pandemic. Views on the latter may influence how policy responds to the former.

While the consensus expects growth around 4.5 per cent this year, after seven per cent last, there is still much pessimism about the future trend rate of growth.

It decelerated following the 2008 global financial crisis. If future growth is low, more of the budget deficit is structural, not cyclical, and needs to be addressed through fiscal restraint – a squeeze on spending or higher taxes. That thinking, which seems to dominate at the Treasury, will be resistant to reversing planned tax hikes for this spring.

Moreover, the economic consensus is that Brexit will exacerbate this challenge. However, despite this common refrain, tax rises are not inevitable. It is not leaving the EU but what you choose to do after you have left that helps determine future growth. In this respect, the Government still needs to articulate a market-friendly pro-growth economic strategy.

It also has bearings for now. There is no easy way to stop a cost-of-living crisis, but the first thing you should do is not implement policies that will make it worse.

The present crisis has multiple components. Inflation that is set to peak at over seven per cent in the spring. Higher energy prices though global in origin, are exacerbated here by decades of poor energy policies, including price caps that are now being lifted.

Furthermore, there have been two separate decisions taken to raise taxes this spring: higher national insurance, and a stealth tax in the form of a freeze on income tax allowances. And then there is a postponement of the triple lock on pensions, which means that they will rise by less than the increase in inflation this year.

Often at times of economic shocks, the search is for a timely, targeted and temporary response – that is, one that addresses the immediate problem but does not change longer-term policy.

Currently, policy is looking at how to support those most in need, which raises questions of how it can be funded.

Temporary financial help as offered during the pandemic would be one approach. It could be paid for by a windfall tax on energy firms. Such a measure would not be ideal, but it has been tried before, for example on North Sea oil producers and banks.

The argument against a windfall tax is the message that it sends. Firms across all sectors may need to factor in that high future profits could be seen as a cash cow by future governments, and this might deter planned investment in the UK by attaching a risk premium to it. Corporate tax rates have already risen, adding to the anti-business perception.

Another option is to cut the five per cent VAT on fuel. The saving, while small, will help those on low incomes. That measure alone, however, would not be enough in itself. And the Prime Minister seems to have ruled the move out as a blunt measure that disproportionately benefits higher earners.

It also appears that the planned tax increases will not be reversed – particularly as the hike in national insurance was effectively presented as a hypothecated tax for health and social care. Reversing this would reopen questions about how to fund the latter.

However, reversing the tax increases makes more economic sense. Not just because it would alleviate the cost-of-living challenge, but because the fiscal numbers, while poor, are improving and mean that such tightening is a choice, not a necessity.

These decisions are not easy. There is no right or wrong answer.  They are about judgement calls – to address the immediate challenge as well as to position for the future.

A current economic debate is about how much fiscal space governments have, despite public debt levels being at an all-time high globally. The debate is less concerned with providing a case for rampant state spending, and more with avoiding being pushed into tightening fiscal policy unnecessarily.

A high level of debt adds to problems, but if the rate of interest is less than the rate of economic growth it creates fiscal space, and improves the chances of debt sustainability. Debt to GDP can be reduced steadily, provided growth is solid and inflation does not let rip. The latter forces rates and yields up, hampering growth.

However, the Bank of England has been asleep at the wheel over the last year. The risk is that the inflation genie is already out of the bottle, as inflation expectations rise and firms increase prices.

In all likelihood, inflation will peak in the second quarter – since some of the initial supply shocks are now over and imported inflation may have peaked already – and, after staying elevated for a short while, will decelerate.

But chances cannot be taken and inflationary risks will force the Bank to raise policy rates this year, and reverse its printing of money by implementing Quantitative Tightening (QT).

We witnessed a short-lived cost-of-living crisis in the wake of 2008, when a weaker pound triggered a temporary rise in inflation. But the last such major crisis was in the mid-1970s.

There is a need not to be taken in too much with current comparisons being made with that decade, since the economy and environment are so different.

While there are not many economic lessons to heed from that period, one springs to mind. In a battle against a rising cost of living, it is vital to have the public on side. Not only so that they can understand the tough policy context, but also in the case of inflation to avoid what are called second-round effects – or put more bluntly, a wage-price spiral.

In June 1975, the annual rate of inflation hit 26 per cent. The then Prime Minister, Harold Wilson, decided that every household needed to receive by post a pamphlet about his policy to fight inflation. I still have a copy.

Entitled Attack on inflation: A Policy for Survival – a Guide to the Government’s programme, its 16 pages made clear why inflation needed to be brought under control. One telling message, in bold capitals was: “the battle (against inflation) cannot be won in one year…but the battle could be lost in one year.”

In the event, the Labour Government lost the battle. Policy focused on a wages and income policy, culminating in the “winter of discontent” in 1978-79. The annual rate of inflation did not fall back into single digits until 1982, after Mrs Thatcher was in power, and also following a deep recession.

I am not advocating such a booklet now, but rather stressing the importance of ensuring that people understand the context of what is happening, especially when here is so much uncertainty and the pain may be severe but short-lived.

The best that can be done is to control the controllables. Provide assistance, ease the pain, reverse the tax hikes, explain why – and focus on a pro-growth strategy.