Pushing the economy to keep Sunak’s promise of inflation is the economics of madness

No sooner had the International Monetary Fund thrown its hands up and admitted – OK guys, we got it wrong, the UK isn’t headed for recession this year – than Chancellor Jeremy Hunt says it doesn’t care if we get a recession. Inflation came down.

As part of economic self-harm, it’s no better (or, more accurately, worse).

If even the Chancellor is indifferent to the prospect of recession before the end of the year, why should any business, domestic or foreign, invest in Britain? Why expand your operations when the steward of the economy is comfortable with contraction?

True, British inflation remains stubbornly high compared to the rest of the world’s major market economies (known as the G7).

It finally fell below 10 percent to 8.7 percent last month, but the fall was less than expected, food inflation remains painfully high, and, worryingly, core inflation (which strips out prices subject to short-term volatility) actually rose. It was 6.8 percent in April from 6.2 percent in March.

Chancellor Jeremy Hunt (pictured) says he will not ignore recession if he wants to reduce inflation
True, British inflation remains stubbornly high compared to the rest of the world’s major market economies (known as the G7). Image leaders of the G7

British inflation is the highest in the G7, higher than Japan (3.5 per cent), Canada (4.4 per cent), the US (4.9 per cent) and France (5.9 per cent).

While the Eurozone average is 7 percent, only Italy comes close at 8.2 percent, which is not much better than ours.

Germany, too, has a historic aversion to inflation — though its economy is now in recession, unlike Britain’s, at 7.2 percent.

But we may have been premature in avoiding an IMF recession.

Its revision came ahead of the chancellor’s ill-chosen comments yesterday, which effectively prompted the Bank to raise interest rates whatever it takes to bring down inflation.

The Bank’s monetary policy committee (which sets the base rate) already has enough people. They think the only way to control inflation is to lower economic activity with higher rates, without further stimulus from the president.

Obviously, this is the economics of madness. Yes, interest rates may need to be raised again from the Bank’s current benchmark rate of 4.5 percent, as inflation is proving much stickier than most commentators (including me) thought.

But do we really want them to go up to 5.5 percent, as markets now expect? It can be devastating for people with mortgages and small business loans.

Chancellor of the Exchequer Jeremy Hunt speaks during the British Chambers of Commerce Annual Global Conference at the QEII Center in London on May 17.

Hunt will get his slack, all right. His finances will also go to hell as falling tax revenue, debt defaults and high spending (with more people) have led to a budget deficit by the end of the year.

The economic outlook is not exactly the one you want in the 12 months leading up to the general election.

The Tories can hand over the keys to 10 Downing Street to Keir Starmer without bothering to fight.

It would be self-deprecating nonsense to accidentally prove that the Tories have lost the plot when it comes to running the economy.

Yes, the fall in UK inflation is very slow. But it is falling. This month will see further fall, which will continue through summer and fall.

It’s still possible that inflation will be below 5 percent before the end of the year (though if the Governor of the Bank thinks so, I might start to doubt my own judgment).

Rishi Sunak has promised that it will be below 5 per cent by Christmas. Does he really want to cut the economy to make sure he keeps his promise? Does it really matter if it doesn’t fall below 5 percent until next January or February and goes to 3 percent or less until next Easter? Is any of it worth the slack?

If that’s the thinking at 10 and 11 Downing Street, it’s political madness. The Prime Minister should never have promised inflation below 5 percent. He and his government did not control inflation.

Rishi Sunak has promised that inflation will be below 5 percent by Christmas

Finally, the drop to below 9 percent from 10 percent last month was due to gas and electricity prices starting to fall after energy prices spiked following Russia’s invasion of Ukraine. It has nothing to do with the UK government.

A sharp drop in overall energy prices will continue to be reflected in lower household gas and electricity bills over the summer. Again, nothing to do with the government.

The institution that fights inflation is the Bank of England, which is independent of the government.

It is right that it has this job because it is responsible for the high inflation.

It pumped more money into the economy during the pandemic, especially after the Great Recession of 2008, on top of the tens of billions it had printed in the previous decade.

Inflation created by the pandemic in global supply chains was merely 'temporary’ when it became clear that the war in Ukraine was putting down roots in economies across the Western world.

That meant it was slow to raise interest rates to fight inflation and forced to rush into some big and disruptive hikes when they finally saw the light.

But just because it was slow to raise rates when inflation first reared its ugly head doesn’t mean it should overdo the hike now.

This is the message that the Prime Minister and Chancellor should be hammering the bank, if only behind closed doors.

Maybe it is. But I doubt it, because it would make the president’s public clamor for a higher price even more incomprehensible.

There is one area where the government has a direct responsibility against inflation: holding a tax against public sector wage demands can lead to a wage-price spiral. So far the government has kept a reasonable fist.

Yes, there are some high settlements. But given how real wages were squeezed after the Great Crash, the system had to give some. I don’t see inflationary wage increases being shot across the board.

Some economists argue that, ultimately, wage increases don’t create inflation, only more money printing does (which is why we ended up with double-digit inflation in the first place).

To them I say this: Fair enough, I don’t necessarily agree with your monetarist theory, but if you’re right, there’s nothing to worry about – all major measures of the money supply are pretty tight right now, so with a delay, your lights-out inflation will soon go down anyway. In fact, there is no need to exaggerate the rise in interest rates.

Just because the government has limited weapons to fight inflation does not mean that it should do nothing.

Britain has made the slowest post-pandemic comeback of any major European economy.

The workforce is even lower than it was before the pandemic. Unemployment is less than 4 percent, but 12 percent of the working-age population is out of work and not looking for work despite more than a million vacancies.

More than 2.6 million people are now on long-term sickness benefit, 440,000 more than before the pandemic.

It slows economic growth because companies can’t fill vacancies, adds to public spending because the benefits bill rises, and spurs inflation by increasing labor costs.

The Sunak administration’s response to all this was totally inadequate. It can only be solved by a massive welfare-to-work program, of which there is no sign.

Instead, the government has decided to rely on record net migration to fill the labor shortage.

This is a pity because while a vibrant economy always requires a fair amount of net migration, it is the welfare of jobs that drives economic growth.

Without growth, Sunak-Hunt is less likely to buy a tax-cut budget next spring, meaning re-election in the fall of 2024 (my best estimate of when the election will happen right now).

Ministers this week jumped at the IMF’s upward revision of our growth prospects for the week, even though it only predicted a paltry 0.4 per cent.

More worrisome is the IMF’s forecast of just 1 percent growth next year. That would be miserable.

Instead of being complacent about recession, Sunak-Hunt should unleash the animal spirits of economic growth.

Without it, all they and their governments are calling for is political oblivion.

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