What can the government do to tackle inflation?

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What can the government do to tackle inflation?

In the latest evidence that the cost of living crisis is making things tough for families across the UK, Sky News recently reported that the average cost of filling up a family car had reached £100 for the first time. According to data from the Office for National Statistics (ONS), the Consumer Price Index (CPI) rate of inflation rose to 9% in the year to April 2022. This is the highest increase in the cost of living for nearly 40 years. In simple terms, goods and services that cost you £100 a year ago will cost you £109 today. As you might imagine, many people want to know what the government plans to do about this problem, but the solution may not be as simple as just flicking a switch. Read on to find out what has caused inflation to surge in recent months and what the government can do about it.

The UK has the highest rate of inflation among the nations in the G7

While countries across Europe have suffered with rising prices in the past few months, the UK is the worst affected. According to the Guardian, Brits are struggling with the highest rate of inflation among the nations of the G7. While this is a complex economic problem, there are essentially three main drivers of inflation: The coronavirus pandemic In 2020, many countries across the globe implemented national lockdowns to help limit the spread of Covid-19. While this helped to save countless lives, this decision led to many companies being unable to operate during this time. As such, there was a fall in the amount of consumer goods being produced. Now that the virus recedes and countries open up again, there has been a surge in demand for goods and services, making their prices increase. The war in Ukraine Another major cause of inflation is the rising cost of food and fuel, largely caused by the invasion of Ukraine in February. Sanctions imposed on Russian oil and gas have caused the price of these commodities to increase, which has had a knock-on effect for consumers in the form of higher energy bills. Ukraine was also a major exporter of wheat and vegetable oils before the invasion, meaning that the price of some foods has gone up as supply chains have been disrupted. According to data from the ONS, in 2021 the UK imported around £830 million of products from the country. The impact of Brexit The UK’s exit from the European Union in 2020 also caused major disruptions to national supply chains. This meant that businesses couldn’t get access to materials as easily, forcing them to raise the price of their products to reflect their higher costs.

The Bank of England could raise interest rates to cool the economy

In the past, one of the main tools that the Bank of England (BoE) has used to control inflation is by raising interest rates. When the BoE chooses to raise rates, it encourages other lenders to raise their own interest rates, making it more expensive to borrow money and more lucrative to save. As spending falls, this helps to reduce the level of inflation in the economy. That being said, doing so could hurt people and businesses who hold a large amount of debt as the cost of interest payments would rise. This could particularly hurt mortgage-holders on tracker- and variable-rate mortgages. In June, the BoE announced that they were raising the base rate up by 0.25 percentage points to 1.25%, the highest level it has been for more than a decade. Given that some members of the Bank wanted to increase it further, it may be likely that more rises could soon follow.

The government could try to influence the supply of goods in the economy to lower prices

If the BoE decides that raising interest rates is too much of a blunt instrument, then another option the government could take is to change its “supply side” policies. Essentially, this involves influencing the supply of goods in the economy and the ability of consumers to buy them. For example, lowering taxes for businesses and cutting red tape can help to make them more competitive and efficient, potentially reducing long-term costs. These savings can then be passed on to the consumers, which would lower the rate of inflation as the price of goods falls. The downside to these policies is that while they can help in the long term, they won’t have much immediate effect and so won’t be able to help struggling households now. Furthermore, tax cuts for businesses would be highly unpopular with the Treasury after the government’s high spending during the pandemic. As you can see, there isn’t a quick fix to the problem of high inflation, which is why the prime minister may be hesitant to act without carefully considering the consequences. Given that most solutions could have major drawbacks, it’s important for them to make an informed decision.

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If you want to know more about how inflation could affect your finances, we can help. Email us at office@verve-financial.com or call 0330 320 5048.
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