Tackling rising inflation and slowing growth: Government’s big decision on how to share the pain

The government cannot insulate all households from the economic slowdown needed to bring inflation under control. Instead the big decision facing ministers is how to share the economic pain. With the Office for Budget Responsibility now predicting the biggest drop in living standards for 50 years, this paper says there is a case for the government to consider targeted help for lower-income households. 

The paper highlights how the 2008 crash and the 1990s recession were caused by a drop in demand, prompting the government to cut taxes and increase spending to boost economic activity. But the current crisis is the result of a shock in supply caused largely by China’s Covid lockdowns hitting global supply chains and the impact of Russia’s invasion of Ukraine on oil, gas supplies and food supplies.  

The resultant rise in inflation has had a greater impact on lower income families. At the same time the pattern of wage rises and slow growth in benefit rates means lower-income households are experiencing slower income growth, while middle- and higher-income households are also more likely to have built up savings during the pandemic, 

The paper says:

• The government should be wary of introducing broad based tax cuts, for example to VAT, or spending giveaways, since these would be expensive and not targeted enough to boost the household finances of those most in need.  
• Targeted options available to the government include raising Universal Credit and other regular benefit payments, or one-off payments such as the Warm Homes Discount, Winter Fuel Payments (for pensioner households) or Cold Weather Payments.  
• Lowering the price of energy could dampen incentives to adopt energy efficiency measures. 
• Ministers should not focus too much on trying to use fiscal policy deliberately to lower inflation; this is job of the Bank of England. 
• The main consideration in setting public sector pay should be an assessment of recruitment and retention pressures – not its impact on inflation.