New figures from the Office for National Statistics report that the UK’s inflation rate has recently risen from 1.5% in April to 2.1% in May. A timeline can illustrate this amongst other months from the past year.
The upward trend of inflation has been due to a surge in consumer spending as confidence within the UK economy has risen as the successful vaccine rollout decreases the risk of COVID-19 transmission. This has occurred despite the new Delta variant of COVID-19 which threatens the UK population, which could be evaluated as a success from the NHS's amazing recent efforts. This has encouraged UK consumers to go out once again and start spending their long saved cash, acquired over the pandemic. This, along with preparation for events reopening again such as Football tournaments, the public have also seen a rise of their MPC and this has also been attributed to the rise in inflation last month.
Due to the boost in aggregate demand within the UK economy for goods/services as the UK has relaxed some restrictions last month, this has caused demand-pull inflation in the UK economy and is seeing an increase in productivity within the economy as retail outlets, bars, restaurants, cafes all seek to supply for the consuming population. As consumption of goods/services contributes to 66% of aggregate demand, this has resulted in a spike in inflation. This benefits the economy as producers are more willing to supply products as are incentivised by being able to charge higher prices for their supplies. This means productive efficiency is obtained within the economy as producers can maximise potential, whilst allocative efficiency is also achieved in a macro sense as maximum utility is achieved. Zooming out to macro levels, the boost in UK productivity has therefore decreased the output gap in the economy. This leads to a decrease in UK unemployment has firms increase factor inputs to maximise their outcomes and therefore revenues, which creates jobs for people, meaning the government can therefore seek taxation revenue in the form of VAT, and also income tax as well. Subsequently, this allows the government to spend on public sectors such as the NHS.
The ONS said motor fuels saw a 17.9% price surge over the past year, representing the highest increase for more than four years. This has been attributed to increased fuel consumption as businesses require more fuel for their expanding logistics operations and consumers are travelling more to consume. This however is an environmental cost to the UK government who therefore struggle to meet macro-economic objectives to become carbon neutral by 2050. Clothing prices also increased by 2.3%, the biggest rise since 2018, as retailers significantly reduced their discounting a month after welcoming customers back into stores.
However, a major drawback of rising inflation is a reduction of disposable income for those on fixed wages, especially for the public sector who have seen a pay freeze and therefore reduced spending abilities as inflation rises. As a result, they can now buy fewer goods/services for the same amount of sterling pound, so then they switch to inferior goods/cut back on the amount of goods/services bought. This can therefore hinder the aggregate demand growth of the economy and reduce the growth potential.
Furthermore, the new inflation rate places the rate above the BoE’s target of 2.0% CPI, however only slightly. But this figure, according to trading economics, is set to jump to 2.5% next month. This means the MPC of the BoE may have to introduce contractionary monetary policy to ensure that inflation does not spiral out of control as it has in America where it has reached 5.0% CPI, forecasted to increase to 5.7%.
Contractionary monetary policy is used to combat rising inflation, as it increases the base interest rates for all banks/loaners in the UK, incentivizing consumers to put money in the bank instead of spending, as it can earn more interest. This as a result lowers the MPC (Marginal propensity to consumer) for consumers and raises the MPS, therefore reducing AD of the UK economy. As a result, this would in turn lower inflation, and get the economy back on track to the government's 2% target for low and stable inflation.
Therefore although inflation is a sign and consequence of productivity in the UK economy, it evidently produces many side effects which must be considered in order to mitigate the negative effects that this can have,
Written by Euan Taylor