Until the Iran conflict broke out, it was tempting to declare the worst of recent inflation behind us. Official consumer prices index inflation had peaked at 11.1 per cent in October 2022, its highest since the early 1980s. By this February, it had fallen back to 3 per cent. At last, there seemed to be light at the end of the tunnel.
In terms of economic damage, though, the inflation shock may yet have further to run. Not just because of the oil price spike, but because of the politics the original high inflation unleashed. The chancellor has railed recently against “rip-off” petrol prices, threatening interventions on petrol stations. The SNP has pledged price caps on bread, milk, cheese and other “essentials”. And the Greens are pushing crude rent controls.
Economists reject such measures. Market prices are not arbitrary numbers but crucial signals about scarcity. Cap them and history shows you get shortages, quality deterioration and black markets. But these proposals do not emerge from a vacuum. They arise when high inflation has so scrambled people’s feel for prices that every jump is seen as an injustice requiring political correction. Indeed, this dynamic is an under-appreciated risk of inflationary policies.
Open a standard macroeconomics textbook and the long-run costs of unexpected inflation listed seem quaint. It generates some arbitrary wealth redistribution, it will say, particularly between lenders and borrowers. It requires costly price adjustments and fuels conflict as contracts get renegotiated and companies eke out ways to maintain custom. Households require more financial planning to protect themselves too.
Yet the dirty secret is that many economists see these as tolerable nuisances, provided inflation quickly subsides. Over time, wages catch up, other prices adjust, and any lasting efficiency damage is supposedly limited. This partly explains why many economists, and even central bankers, were so sanguine about massive monetary and fiscal stimulus in the pandemic. A slower recovery seemed the greater danger. If inflation expectations stayed relatively “anchored”, any damage from inflation overshooting was deemed manageable.
The public implicitly understands that inflation is far more corrosive than this, even if they cannot articulate why. Yes, there is the temporary wage squeeze economists acknowledge, whereby consumer prices jump first, with pay rises following later for many workers. But the lingering problem is how a sharp rise in the price level makes everyday life more confusing.
I still get bamboozled in supermarkets about whether certain prices are high relative to substitutes, or merely what everything now costs. Once people lose a sense of what “normal” prices are, and become more attentive to movements, it’s a short step to seeing greed where there is scarcity, and profiteering where there is pass-through.
Bad policy then amplifies the original damage. Faced with high inflation, politicians’ first instinct is “relief”. Britain got the vast Energy Price Guarantee and waves of cost-of-living support. These cushion families’ finances, but cannot eradicate the underlying inflationary pressure. They shift its burden around and by sustaining demand, keep inflationary pressure elevated.
The next reaction to lingering voter anger is price controls. The SNP’s food price caps and the Greens’ rent controls, just like the government’s vet price caps, rail fare freezes and more, shroud the information prices provide, creating harmful incentives. By squeezing margins, they discourage supply, while incentivising other damaging adjustments from landlords or retailers to circumvent or ameliorate risk.
Once inflation violently resets the price level, politics thus rarely stays economically rational. Every salient price rise becomes a scandal. Every supply shock is dubbed exploitation. Politicians stop asking about causes, and instead police symptoms.
By corroding public trust in the price mechanism itself, high inflation thus clears the way for exactly the populist price control proposals now multiplying across Britain. This political aftershock is a cost of high inflation that few acknowledge, but one future policymakers should not ignore.