Bim Afolami is MP for Hitchin & Harpenden.
My father came to this country during the 1980s, from Nigeria, to complete his training as a junior doctor. Thankfully this country is where he chose to make his home, and it is the only place that I, and my younger brother and sister, have ever known and loved.
Yet we grew up hearing a lot of stories about what it was like growing up in a country so different to our own; partly to give us a firm understanding of the journey that our family has taken, but also to demonstrate the importance of sensible government and basic, competent management of the economy – something which in Britain, regardless of our political differences, we take for granted.
He told me a story of how he, as a junior doctor and son of an Anglican cleric, was rather impecunious, but had carefully saved the Nigerian equivalent of £24,000 then (about £94,000 now), which he wanted to use as a deposit for a home.
However, during the late 1970s, the Nigerian oil boom meant huge inflation, which, combined with continuing military rule, killed the value of the Nigeria naira – which meant that within a year, he was left with cash worth under £1,000.
It is not an exaggeration to say that his experience of the social and economic experience of the late 1970s in Nigeria was so negative it made him leave the country and seek a better life elsewhere. From this family story I was taught the importance of inflation which has stayed with me ever since.
Inflation may become a defining feature of politics over the next few years.
Inflation was a significant political issue from the 1960s until the early 1990s. There were a series of energy crises between 1967 and 1979 caused by problems in the Middle East, but the most significant started in 1973 when Arab oil producers imposed an embargo.
The decision by OPEC to punish the West in response to support for Israel during the Yom Kippur war against Egypt led the price of crude to rise from $3 per barrel to $12 by 1974. Consequently, the price of petrol rocketed, making all transport more expensive as well as making British industry uncompetitive.
Ted Heath’s government was already struggling to cope with high food prices caused by global shortages, so the oil shock fed into an inflation rate which, by August 1974, hit more than 24 per cent. Inflation never hit quite those heights again, but it averaged about 10 per cent between 1974 and 1992.
This potted history matters, because the politics of that period were completely shaped by the impact of inflation – the wage and incomes policies, the wage demands of the unions, the extremely high interest rates, the currency crisis which precipitated Jim Callaghan’s Labour Government going to the IMF in 1976, the three million unemployed in 1983 – and much else besides.
I am not, for even one moment, suggesting that history is about to repeat itself in any of the above respects. However, I am trying to demonstrate that when inflation is high, governments find it incredibly difficult to bring it down, because many of the causes for inflation are typically global, and high inflation results in tricky political choices.
The 2021 version of the 1973 oil shock is Covid 19. The world shutdown of economic activity and trade hugely affected supply chains, and literally shut them down in many parts of the world.
When almost all economies fully opened earlier this year, the demand for goods worldwide skyrocketed, and has continued to do so. It is this imbalance between supply and demand that has caused the bulk of the inflationary spike.
In addition, huge amounts of necessary government spending to cushion the blow of Covid on households and businesses increased the disposable income of millions. All of this extra spending power and demand is chasing fewer goods. It is worth noting that, notwithstanding the global factors, there is one major driver of inflation that Governments do indeed control – public spending and public sector wages. It is clear that th Treasury will be monitoring these carefully over the coming years.
As a result of all of these factors, inflation is up. The Bank of England’s latest forecast projects inflation to peak at around five per cent in the second quarter of 2022, and many City figures I know think this could be an underestimate.
Though that may be relatively low compared to the 1970’s, with interest rates still below one per cent (though these will creep up slowly), this inflation will erode the spending power of households to a noticeable extent. Interest rate rises may not be very effective at dealing with the inflation we are seeing now, because the causes of inflation are largely driven by a combination of exogenous factors that are not affected by them; ranging from global supply chain problems and energy supply disruption to a build up of excess money supply (through quantitative easing).
Amongst economists, a debate is currently raging about how transitory, or permanent, the inflationary spike will be, and this debate is being played out within the Bank of England’s Monetary Policy Committee – with regards to how quickly they raise interest rates.
I do not intend to get into the weeds of that debate here, but as a politician thinking about the political impacts, we should start planning for an elevated inflation rate (three to five per cent) for at least the foreseeable future. This will mean three key things.
First, interest rates will be going up, and that will mean higher costs of not just mortgages, but anything bought on finance, such as cars, household goods, and furniture. More importantly, it will affect the cost of our daily bread and basic foodstuffs.
We should never forget about the millions of people who are “just about managing” – they will find it harder to budget for their families over the next few months. In addition, any interest rate rise will curtail consumer spending – which may dampen down the speed of our remarkable economic recovery post Covid.
Second, energy prices are already rising and are likely to rise further. Again, this will be very directly felt by the electorate.
Third, there is the impact of rising interest rates on government debt repayments and the Government budget overall. The OBR says that just a one per cent increase in rates would add £20 billion to government debt repayments each year, and interest rates could rise further than that if inflation stays at an elevated rate for a while to come. £20 billion is roughly half the defence budget. Interest rate rises will make the Chancellor’s life even harder here – especially when coupled with ever increasing demands for more public spending, itself a domestic driver of inflation.
As higher inflation and rises in interest rates starts to bite, this will get to the heart of voters’ experience of the economy. They won’t care about statistics but, instead, will think about whether they can manage to pay for their daily costs, and whether they might be able to save enough to buy their kids a nice birthday present, or replace the car that keeps breaking down.
Wages are rising fast in some sectors, particularly for lower paid workers and for workers with scarce skills, but this won’t be for everyone and millions of households will have to tighten their belts. Our Plan for Jobs has been a resounding success, but after the winter we may need to plan for managing inflation.