By Elena Siniscalco
It is hard to believe only a week has passed since Liz Truss made the announcement that was set to immediately define the start of her premiership; a blanket cap on energy bills so that the average household pays no more than £2,500 a year.
After being harried for weeks by the opposition parties, she went further than both, pledging to keep the support in place until the end of 2024. The new prime minister also promised support for all organisations over the next six months, before a targeted scheme is launched in April. So much for no handouts, Liz.
The eye-watering increases in energy prices meant that contrary to her protests during the leadership election, she was always going to have to intervene in the market to an unprecedented extent. And her package should stop households being plunged deeper into poverty. Likewise, if they can move quickly to finalise the details, the corporate package should save many if not most businesses and keep schools and hospitals open.
But what they have not done is address the fundamental problem; that the breakdown in relations with Russia means there is less gas available for European consumers. While Britain was less dependent on Russian gas than our European neighbours, we were more exposed to the price shock because we rely more on gas for electricity generation.
But by keeping prices artificially low, the government has made shortages more likely by reducing people’s incentive to reduce usage. Unlike European countries we have not spent the summer building up our stores of gas. Nor have we followed the European Union’s lead in setting clear targets for reducing energy consumption. The government is making gestures towards expanding energy supply by supporting greater domestic production, but this will make no impact this winter. Loath to implement formal rationing, Truss is left hoping that previous energy price increases earlier this year and a mild winter will together keep demand low enough to be sustainable.
If the government hasn’t solved the energy crisis, it may well have made the problem of inflation worse. Mechanically, holding down energy prices reduces inflation, because as a consumer product and industrial input, it is a key part of the basket of goods from which inflation is calculated.
But this is the economics of children. If reducing inflation was that simple, then every government would respond with price controls and consumption subsidies.
In reality, such an approach was abandoned in the seventies because manipulating sticker prices ultimately exacerbates core inflation. The government announcement means people will have more money to spend in the shops, because less of their income will be eaten up by their energy bills. The evidence from America is that this will keep prices of other goods unusually high; Tuesday’s report on US inflation was higher than forecast as people spent the money they saved from falling gasoline prices. Likewise, with UK unemployment at historic lows, saving businesses from going bankrupt will increase competition for workers, which will drive wages up. Ultimately, this will be reflected in higher prices for everyone.
Making a significant investment of public money to keep people warm and businesses operational through the current crisis was unavoidable given the failure to properly prepare. But it is positively reckless for the government to fund this through continued borrowing. Indeed, it has doubled down on this gamble by forgoing tens of billions of pounds in revenue as it proceeds with ideological plans to cancel the increases to National Insurance and corporation tax.
Everyone in Westminster is determined to ignore reality: lockdowns in China and war in Ukraine are not the only reasons for high inflation. There is simply more money in the economy than it can handle, and that is also fuelling inflation above and beyond the short-term issues with commodities. The economy does not need over £200bn pumped into it, as that will only encourage greater personal consumption, fiercer competition for workers, and higher inflation. And the answer to such fiscal incontinence in the face of high inflation will be a painful monetary contraction, with higher interest rates impoverishing homeowners and starving industry and infrastructure of much needed investment.
Liz Truss and Kwasi Kwarteng may be promising to keep us warm this winter, but by running the economy this hot, they will leave us all in the cold for years to come.
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