Pent-up demand is temporary and the prospect of a third wave, with all its economic havoc, is very real
Britain is on the verge of a historic moment. More than a year since the Covid-19 pandemic began, the endpoint for all social restrictions is within touching distance as spring slips into summer. An announcement is expected from Boris Johnson on Monday.
Delay rather than a reopening on 21 June is the most likely decision, as the spread of the Delta variant fuels a third wave in coronavirus infections in the UK. Far from the “freedom day” we had hoped for, we are at yet another moment where the prime minister has built up hopes and then disappointed.
Despite this critical juncture, there has been very little focus among economists on the economic consequences. Far from worrying about the cost of delay or a renewed Covid-19 slump, more attention is being paid to the dangers of the economy overheating. We are warned not that growth is at risk, but that a dangerous inflationary beast is stalking the land once more.
It is a moment of marked contrast to last autumn, when, despite red-hot economic growth coming out of the summer lockdown, many economists remained concerned about downside risks. Andy Haldane, the Bank of England’s chief economist, warned at the time there was “chicken licken” pessimism on the pages of national newspapers, embedding a self-fulfilling prophecy for weaker growth by encouraging undue caution among consumers and businesses.
Haldane, who leaves the Bank later this month to run the Royal Society of Arts thinktank, is now among the most prominent economists warning of the risks from an overheating economy, using a column in the New Statesman to say Britain is at the most dangerous moment for inflation since the exit from the European exchange rate mechanism in 1992.
There are good reasons for focusing on these upside risks. The signs are promising that Britain’s economic recovery from Covid-19 is under way at last. Growth has returned with gusto – GDP rose by a bumper 2.3% in April alone as lockdown measures were relaxed – fuelled by rising business confidence and consumer spending as restrictions eased.
Allowing the economy to overheat would imperil the purchasing power of hard-pressed families, while a new period of boom and bust would dawn. Interest rates would need to rise, financial markets would be thrown into a tailspin.
But just as there were warnings of undue pessimism last autumn, there are risks from overemphasising the strength of the economy and the dangers for inflation. You could say it isn’t a time to count your chickens, when the story of the Covid-19 pandemic is far from over.
There are doubts about whether the current inflationary burst is simply a bottleneck moment, or the early signs of lasting upward pressure. After shutting down much of the economy last year, growth was always likely to race ahead once activity was allowed to resume.
Over the short-term, demand is being driven by £200bn in savings built up by mainly wealthy households who had limited ability to spend their incomes during lockdown and are now looking to make up for lost time. It is billed as a trickle-down economic benefit for shops, pubs, restaurants and cafes that were forced to close. But questions remain about how much will be spent, and how quickly. It is also hardly a permanent feature of the new post-Covid economy.
On the supply side, businesses are struggling to find staff, prices for raw materials are soaring, while shipment costs have surged. Some of this is down to pandemic-related issues: international travel restrictions, disruption to global freight movements, and the need to implement Covid-safe environments. Though these are likely to fade over time, legitimate questions remain about how much pressure will remain – especially as Brexit starts to bite. But in the short-term, a few restaurants offering one-off bonuses for new staff is not sufficient evidence of a permanently tighter labour market.
Among the inflationistas are those who would argue that the best approach to reining in spiralling prices would be to shrink back the size of the state, after a record expansion in fiscal activism during the pandemic. This, they argue, has stoked demand far out of proportion to supply, in a frenzy of furlough cash, tax cuts and cheap, easy-access business loans.
However, this wilfully ignores that the government already plans to close the furlough scheme and end its emergency tax breaks. Public sector pay is being frozen, corporation tax will be raised, while further constraints to state expenditure ought not be ruled out under a Tory party ill at ease with gaping government borrowing figures.
There are dangers from racing down this path to combat inflation, at a time when the pandemic remains a risk to growth and jobs. It would also undermine any attempt to “build back better” from the crisis.
It is a warning expressed by economists at the Institute for Public Policy Research and the New Economics Foundation. Carsten Jung, senior economist at the IPPR’s Centre for Economic Justice, says: “If we pull support measures and the economy never fully bounces back, there would be scarring for businesses, the labour market would never fully heal, and as a result the economy would be doing worse in the medium and long term. That is the risk of doing too little.”
The New Economics Foundation will this week highlight the risks of a broken social security system in Britain trapping millions in poverty. To tackle inflation by sapping demand from the economy would hurt poor people most. Alfie Stirling, director of research and chief economist at the thinktank, said: “If we fail to maintain sufficient heat in the economy, we know with a lot of clarity that the long-term costs are permanent scarring. It is suppressed wages and higher unemployment, precisely because we’ve engineered a lower equilibrium than would otherwise be the case.”
Given the heightened economic risks of delay on 21 June, this is a moment for caution rather than inflation alarmism. The costs of acting to prick a short-term inflationary bubble, which may not fully materialise, would be too great.
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