Two Inflation Narratives For Britain’s Ills Are Fighting For Supremacy
Only one is gaining a lot of traction at the moment
Inflation is hitting the United Kingdom hard, and we have changed prime minister twice in as many months. The ascension of Rishi Sunak and his unified cabinet of talent and party factions has soothed market nerves and (we hope), left behind the circus of the Johnson era and the rollercoaster of the Truss era.
Most people of all political persuasions seem to be genuinely relieved that Sunak has replaced Truss, and the immediate crisis is over. But there’s an increasing malaise where even firm Conservative voters appear to be loosing heart that Sunak will right the ship of state and set Britain back on a course for growth and prosperity, or whether he’ll be gone within a few months as well.
In trying to assess that, one of the most important and overlooked stories of the time has to be about the causes of inflation and the narrative the government is telling both itself and the people of the UK about what is causing it. Without a sufficient handle on the UK’s problems, the government will be unable to do anything other than move into the next crisis, and the next crisis after that.
So why is the narrative around inflation so important and why would it cause further crises?
Well, there are two competing narratives. They are probably both true at the moment to some extent, but each narrative requires different actions to be taken and those actions act against each other. If the government buys into the wrong narrative, then economic chaos will ensue. In fact, the spectacular implosion of the Truss Prime Ministership might be the first sign of this already.
One narrative of current inflation is that it is mainly being caused by supply shocks, much like the oil shocks of the 1970s. In this reading, the recovery from the Pandemic followed by the War in Ukraine has caused a supply side crunch.
In this reading, the best way to work your way out of this is to invest in the country. Investment in the UK is handled mainly by the private sector. Stimulating that investment either through direct investment by the government or via tax cuts isn’t a terrible idea, while tamping down on unions and getting people through the bad times to a point where the economy starts working again is key and avoiding a wage price spiral, where wages go up causing prices to go up, is key.
The only questions are rather about the incentives for this recovery (e.g. green-led or more fossil fuel based) and how to encourage the private sector to invest in the right types of industry.
The other narrative argues that inflation is mainly caused by the outrageous sums of money that were printed under Quantitive Easing by the Bank of England, both during the pandemic and beforehand, that are finally making their way into our economy.
Prices aren’t really going up so much as the value of money is going down and all prices need to stabilise as a result. Nothing is going to stop this kind of inflation other than letting it run its course.
Of course, if the value of money is dropping, so are people’s wages. In real terms, people will be taking what are effectively huge page cuts. Stopping people’s wages from also going up to match will make those pay cuts real.
As people loose significant amounts of money from their wages, spending cuts back and many who were just about managing, or had some breathing room, may suddenly slip under the point at which survival is possible.
Equally, government spending on services will also have gone down in real terms, as current spending will be able to achieve less for the same price.
Under the Truss leadership, it was very clear that she (and by extension the Conservative members who backed her) had bought into the first narrative and the first narrative only.
However, I’ve been hearing both narratives inside business and perhaps it’s not surprising that the markets did not think much of her plan. If anything, it argues that businesses think the second narrative is much more powerful than Truss gave it credence, making Truss’s actions appear reckless.
Sunak seems to have grasped some of this complexity, but if these narratives are as powerful as they seem, he will politically live or die by how well he understands them.
The opposition party, Labour, is framing policy around the second narrative as the Cost of Living Crisis, going on to predict that things may not be so rosy once people in the UK realise they’ve all taken huge pay cuts and large cuts to public services, meaning Sunak will have an effective opposition making a good case for the second narrative.
But while Sunak seems to have grasped some of the complexity around the two narratives, on the whole, Conservatives seem to be avoiding the topic and are still mainly pushing the supply shock narrative. If so, that does not bode well for Sunak, regardless of what he believes in terms of giving him the manoeuvre room to have sensible policies.
In fact, the Conservative position may well be ungovernable because the Conservatives may not be ideologically or pragmatically able to accept the second narrative for a variety of reasons.
Of the many reasons that conservatives might not be able to accept the second narrative, two stand out.
The first is that, by standing back and doing nothing, the Libertarian wing of the party gets what it wants, a low wage low regulation economy, and it does not have to pay a political price from actively making it happen.
Rather than making a case that a low wage low regulation economy is a good thing and convincing voters to vote for it, they can cast the narrative of crisis and of hard decisions to fix those crises. Whether people will blame Conservatives for that crisis in the first place is another matter.
This leads to the second issue, which is Brexit. If lots of money is sloshing around the system that hasn’t yet caused all the inflation it needs to, then it’s also making Brexit look better than it really is.
Many people argued that Brexit would drag down UK economic growth by 4% each year. As with most things that compound, that kind of change does little at the start, but becomes terrifying over time.
Many who predicted doom and gloom after leaving the EU based their analysis on the idea that, if the economy stagnated or even contracted, then politicians would have to level with people in the UK and get them to decide how to handle being poorer compared to their European cousins, whether that’s accepting cuts in services or higher taxes. People would then see Brexit for what it is.
The second narrative, however, destroys that link by depressing wages and public funding anyway. For now, Brexiters can genuinely live in a period where Brexit hasn’t been the disaster it was predicted to be since no one has had to have a cut in the value of their wages, even if what they can buy with them is much less, leaving the causes of economic failure and rising inflation open to interpretation.
Sunak himself is someone who thought Brexit to be a great idea and should he and the Conservative Party be ideologically unable to come to terms with Brexit, they may just bake rising inflation into the country indefinitely as they try to pretend all is well by printing large amounts of money to make it work. Increasingly, their Brexit stance will drag them into conflict with the Bank of England, which is now trying to cut inflation, as has already happened under Truss.
Whether it is Brexit or the other ideological issues the Conservative Party are facing at the moment, it may yet be the unresolved issues that Sunak won’t face that will drive the Conservative Party back into crisis and end his Prime Ministership the way it ended his predecessors.
However, he may yet surprise us all and be far more pragmatic than any of us realise. If he can get a handle on the real problems and convince his Party to follow, there may be a path for him to survive until the general election, where the voters of the UK will be finally asked their opinions on the two narratives, and which party they would like to lead them in the future.
Whether the voters of the UK will tolerate more Conservative missteps is another issue.