Solving the UK Energy Price Crisis

The UK energy price spike should be addressed directly and the rest of the economy isolated as much as possible from its effects. Many of the complex solutions proposed (building on the subsidy-based approach we’ve already begun) will not only be only partially effective, but will also exacerbate inflation and the coming recession as well as risk unintended consequences, such as allowing those on low to middle incomes to slip even further behind the higher paid.

Have the UK’s policy-makers completely lost their marbles? Are they actually focused on minimising:

(1) The number of people unable to heat their homes this winter;

(2) Inflation;

(3) The coming recession.

Or not?

The Resolution Foundation (RF) suggests, for example, that:

“It is vital that a new policy intervention accounts for household incomes and energy need… A social tariff, whereby qualifying households are offered a discounted rate on energy bills could be the ideal solution, with a 30 per cent discount for low-to-middle income households offsetting the increase in energy costs…”

Summary of RF report A Chilling Crisis

No, no, no. Just keep things simple.

I’m reminded that I made the point in an earlier post that directly reducing the per kWh cost of electricity and gas would reduce inflationary pressures in the economy. Help targeted at just the poorest households would simply not do that.

Several months into this crisis my gut-feel is that the best approach is to solve energy prices with one policy and (given the UK’s chronic income inequality problem) separately redistribute income with another (well, others!). Don’t try to be clever and do both at once, especially in a crisis.

I know that sitting in the Treasury it makes sense to allow prices to rise, while giving out some cash to mitigate the worst effects. People will then have a big incentive to reduce energy consumption. But (among other problems, including inflation) there isn’t time for that to happen – how many households will improve their insulation in the next 3 months? Besides, energy prices have already risen sufficiently to motivate energy saving measures. I know I’m questioning every Watt of energy consumption chez Joslin.

Specific problems are becoming clearer, but there is no time to work through them all. It turns out that some households need to use far more electricity and/or gas than others. For example, some people need to charge electric wheelchairs or operate medical equipment.

Businesses as well as consumers need support. Otherwise prices will rise anyway and insolvencies will guarantee a deep recession (i.e. two of the trifecta of problems in my opening paragraph will be exacerbated).

But there’s another problem with “targeted help”. Guess what – there’s an unintended, but likely consequence. Who’d have thought?

Those on higher incomes will demand pay increases to compensate for the inflation they’re experiencing. And, in many cases, they will get those pay increases, because the reason they are on higher incomes in the first place is that they have more power in the labour market. This creates further inflationary pressure, of course.

Those on lower incomes will not see similar increases in their income, especially if the minimum wage isn’t increased sufficiently. And there’s no reason why it would be, because those on lower incomes would be receiving direct support with their energy bills.

You’re probably way ahead of me. The energy bill support will eventually come to an end. At which point those on low incomes will find their wages have slipped further, relative to higher-earners. An unintended consequence.

There’s also the problem that allowing energy prices to rise rapidly for some people but not others muddies the inflation waters. How would we know what the inflation rate actually is in these circumstances? It’ll be very different for different groups, complicating pay-bargaining, among other things.

I stress this point, because, if we want to avoid a recession, wage increases need to (at least) approximate inflation. Otherwise there will be less demand in the economy and we’ll enter a death spiral as consumer-facing businesses go bust, reducing demand further…

To be honest, I don’t see how a nasty UK recession is now avoidable, since higher interest rates alone will soon lead to increased mortgage payments reducing not only disposable household incomes and consumption, but also our chronically inflated house prices, and thus activity in the housing market and construction.

So, I think this is a time when it makes sense to be nice but dim and:

(1) Use windfall taxes on energy producers and government borrowing to freeze energy prices for all consumers, both domestic and commercial. This will reduce inflationary pressures as well as energy poverty.

(2) Allow benefits and incomes to rise in line with inflation because there is already significant inflation in the economy. This will reduce the depth of the coming recession.

(3) On no account increase taxes immediately. The RF suggests:

“If there is no time to implement this [targeted help with energy bills], a similar result could be delivered through a [sic] lowering energy prices for all, and recouping some of the cost, and reducing what would otherwise be large gains to better-off families, through an additional 1p on all rates of income tax.” 

Summary of RF report A Chilling Crisis

It is essential that any such tax rise is deferred if we are to avoid a deep recession. In fact, if I dare say it, some fiscal stimulus might be necessary. I note that PM-in-waiting Liz Truss is proposing some tax cuts.

We’ve more chance of managing the inflation, recession and social risks if we look at the gas price spike as something we need to prevent, or deal with at source, rather than try to address the consequences when it hits the economy.

Modification history

28/8/22: Modified precis shortly after initial posting.