Author: johnredwood

In recent years a lot of economic advice and analysis has got too complex and out of touch . As a result  the Bank of England misread inflation and presided over a major surge in prices that set in  before an unexpected and unwanted European war made it worse. The Office of  Budget responsibility in the last two years was way out in its underestimates of tax revenue and far  too pessimistic in claiming a need for tax rises to cut the deficit. Its models did not realise revenue can be strong when there is more growth. Throughout the West the authorities decided fast money growth did not matter, and Central Banks could keep interest rates at zero whilst buying up state debt in large quantities so governments could borrow plenty on the cheap.

Central Banks are now wanting to correct their past inflationary mistakes, and are turning instead to tough money policies, pushing up interest rates, reducing their holdings of state debt and taking cash out of markets that might otherwise drive up prices. The danger is they now overshoot too far the other way, leading some countries into longer and deeper slowdowns than are needed to curb price rises. The new PM does not want the Bank to go easy on inflation, though it would also be bad news if they grew too tough. It would help them get it right if they took the growth in money and credit seriously, and watched those figures alongside evidence of any change in behaviour about how quickly the money circulated. They have tightened money substantially as they needed to do and should now wait for the impact on inflation to come through.

The new government team should want the Bank in its required reports on why inflation is running above target to provide its latest analysis of why inflation is five times target and to report on what actions it is taking to amend its models to help it forecast inflation more accurately. It would be good to hear from them about what role they now recognise the large programmes of buying bonds played in the inflation. More importantly they need to consider carefully how much impact rolling back all those bonds will have, as  it will cut liquidity and slow the economy. It will make borrowing more money by the government more difficult and more expensive. Some of that is necessary.  Too much of that brings on recession and paradoxically increases the debt and deficit as a result.

The OBR forecast of £99bn as I have argued before for this year’s deficit looks too low and needs to be adjusted. Without policy stimulus the economy will slow too much which will cut revenues and raise spending. With a policy stimulus which now seems likely some of the slowdown will be offset but there will be greater borrowing to cover the stimulus costs of helping people with their energy bills.

If the government decides on a large increase in state borrowing it will need the goodwill of the Bank and the markets to finance its needs. Raising the money from the long bond market is not inflationary. If rates go too high in the process that will impede growth. If Sterling falls too far that will import more inflation. There need to be sensible limits on public spending and borrowing.

Below you will find my latest Conservative Home:

Venezuela has been brought low by printing lots of money, by price controls and nationalisation. A potentially rich country with the world’s largest oil reserves, Venezuela has seen its income per head fall from $12,000 in 2011 to just $1877 last year after a decade of price controls and nationalisation.

Zimbabwe, once a relatively prosperous agricultural state with plenty of food has seen its income per head fall to $1362 a head and lived through food shortages. Compulsory land transfers and price controls have not been kind to the economy.

Sri Lanka  has been less extreme but has seen its income per head fall to $3698 last year and experienced food and other shortages as controls have been used. As a Professor at Colombo University wrote of their price control “it has never sorted out our supply shortages, but is has eliminated the quality goods from the market, and it has created a black market for good quality products, and it has not helped in any way eliminate poverty”

Food riots, protests against government, high inflation and damaging price controls have created misery in each of these potentially successful countries. Price controls have taken too many goods off the shelves, have bankrupted businesses that could otherwise have supplied more, have driven foreign companies out and put off more investment in capacity to supply. They have bred black markets, fostered smuggling subsidised and price controlled goods out of the country to sell at better prices elsewhere and prevented imports.

Why do so many people think they would work? Why will they not study what happens when they are used widely in inflation ridden economies?

Let me begin by making it clear I do want government to ensure everyone has sufficient money to be able to keep warm and do their cooking this winter. That is best done by allowing people to keep more of their income through tax cuts , or by giving people more in benefits to cover the bills who cannot earn. This blog is about the underlying problem of high prices and how you solve them.

Most people want there to be an easy answer to the ultra high prices of energy. Some say just stop any price increase for any energy sold to anyone. Some say control the prices of oil and gas that producers  from  UK reserves can charge us. Some say stop the renewable producers charging the same price for their electricity that the gas based producers have to charge now the gas price has gone up. Maybe there is a way to do the latter that the industry would accept, but they do need to be able to make a profit on their investments and need some long term visibility on contracts. The first proposal would stop all price rises. The second and third would stop some of the price rises, but would leave us paying the new high prices for all imported fuels and for the items of domestic production they leave out.

All these schemes mean government to a greater or lesser extent stops price doing what price will always do, balancing available supply with available demand. Higher prices now surging if left in place  will solve the imbalance. All those in business or on better incomes  who can economise on their power use will now do so, reducing demand. The state will need to rein in its extravagant use of energy by reviewing its over night street lighting, its heating and lighting of little used offices and the rest. Better off households will reach for the thermostat or timers to slice a bit off their past use. So demand will fall.

More importantly the price signal will incentivise businesses to put in more capacity to produce energy. Oil and gas producers will be encouraged to bring forward marginal new prospects that used to be uneconomic for development. Renewable investors will have more profits to plough back into additional capacity or into all important storage. In the short term energy companies will sweat their current assets more to maximise output. In the medium term they will add to their stock of producing assets and in the longer term the whole industry stands a better chance of achieving major commercial throughs with nuclear, battery, hydrogen and other technologies.

If you stop the energy industries in the UK earning the extra revenue from high global prices you will divert profit and investment capital away to countries that do allow them the benefits. If you stop them charging world prices they will divert as much of their current product as possible to markets where they can charge more. Anyway you look at it, price controls prevent more supply and impede lower demand from energy saving. It is no accident that the countries that have relied most on price controls are often those in the lower income bands worldwide, short of domestic supply.  I will deal with those who think that means the answer is nationalisation in a later blog. That too would make the position worse.

I read various bizarre articles defending the Bank of England’s independence against an imaginary threat from Liz Truss. I only know what she has said in public, where she issued no threat to Bank independence. She said she favoured a review of the Bank’s mandate to see if it met best standards in the world of independent Central Banks, and to find out what can be learned from the Bank’s failure to forecast or prevent the high inflation we now suffer. The inference was she wanted a tougher Bank,  not a Bank that printed more money and artificially depressed interest rates to suit the government.

The articles are bizarre because they always ignore the radical change to Bank policy launched by Mr Brown and Mr Darling and continued by all subsequent PMs and Chancellors. They agreed with the Bank a policy of creating more money and buying up state debt to keep rates down. Right from their start of this policy it has been a dual control policy, with the Bank needing the consent of the Chancellor and requiring a full Treasury guarantee or underwriting of the transactions. As this policy has dominated money policy between 2008 and 2021 we cannot say the Bank was then genuinely independent. It does have and did have throughout the sole power to fix the official interest rate. No-one in this debate is recommending taking that power away.

Going forward I would like to see the Bank introduce quantity of money and circulation of money as important information to monitor and take into account when settling interest rates. It has proved difficult to control inflation whilst allowing a large increase in the money supply triggered by substantial Quantitative easing. The Bank may not want to go back to strict money targets that were used in the early 1980s to end the last big inflation, but monitoring money and showing an awareness of its importance might  help them  make better calls. The current money figures show they have  now reined things in considerably. They do not need to overdo the tightening from here to make the opposite error to being too loose as they were in the previous two years. The IMF does usually call for monetary discipline when it puts in a recovery programme for a state that needs financial help.

When Rishi Sunak announced a £400 payment to every electricity  bill payer I was concerned about that way of offering some relief. I would have preferred tax cuts on energy which would directly cut the CPI/RPI measurements of inflation. The government thought these cash payments might qualify as reductions in energy bills and help the CPI figure. Instead after considerable delay the ONS has decided to call them “current transfers” to households that do not cut the price of power.

They rightly go on to remind us they have the legal power to make a judgement about such matters, They say “Decisions on whether to include rebates, subsidies and discounts in our consumer prices inflation statistics are taken on a  case by case basis”. As these £400 payments cannot be withdrawn and spent on anything else but take the form of a cut in the electricity bills that need to be paid there is a perfectly good case to say this is a cut in the price of electricity for all users.

All this matters. Allowing the full bill cost to boost the CPI without allowing for the discount that is available means we face higher inflation with all the knock on effects. This decision will increase public spending and the deficit given the way some spending items are directly linked to the inflation index. It raises the repayment amount for indexed debt.  The Treasury should have asked the electricity companies to put it on bills as a discount to the price of power, which is what it is. A sum equivalent is  payable by the Treasury to the companies as a subsidy. This is another missed opportunity.

Many people argue that instead of producing more of our own gas to cover some of the energy shortfall we need to press boldly on with more windfarms. They argue that now wind energy is cheaper than current gas prices, so it makes economic sense as well as environmental.

If only it were that simple. Many have pointed out that the problem with wind energy is it stops when the wind does not blow. It does not matter how many windfarms with how much rated capacity you install if the wind does not blow. Wind turbines also cannot function in very high winds. But there is an obvious more practical problem for those who say  the answer lies in a blowing wind. Most UK households this winter will heat their rooms and water using gas. Renewable electricity would be no use to them. Most industrial processes use gas rather than electricity. Most commercial premises are fuelled by gas.

Until most households, most factories and  most offices  have been through their own electric revolution we will need  more gas as electricity cannot power it. The issue is do we produce the gas ourselves, with greater reliability and tax revenues flowing to the UK state, or do we import it with tax revenues and jobs flowing to the overseas provider? Is there going to be a hydrogen revolution, where it becomes commercial to use windpower to create large quantities of hydrogen which can be used to fire our boilers? If so that does not solve the problem for the next few years whilst this is planned and installed.

In all the grand green plans gas is down there as a transition fuel. In all the plans there is an acknowledgement that the world as whole will be using more oil and gas at the end of this decade than it did at the beginning. It will be more reliable, collect more tax revenue generate more jobs and vent less CO2 if we use our own rather than rely on imports.

The UK government has recently published a consultation document on possible reform of the management and regulation of the UK electricity industry.

The UK fell under the EU system of control and regulation, which was progressively tightened and embodied in the 71 page 2019 Regulation. This Regulation wished to achieve two main aims, the integration of a Europe wide system of power provision and rapid progress to decarbonise the electricity used.  The two aims were self reinforcing. The Regulation warned that as more power came from  interruptible renewable sources there would be more need for interconnectors to allow the import and export of power across national boundaries to compensate for shortfalls in supply. The UK duly obliged even though we were in the process of exiting the EU, continuing its drive to rely more on interconnectors to the continent and very willing to add large extra volumes of wind energy to the system.

In line with other European countries the UK had developed twin market interventions to bring about the net zero progress. More low carbon power was attracted by offering long term contracts at guaranteed prices. In the early days of renewable power and for nuclear these were at premium prices to the then market wholesale price. The investors putting in the new capacity agreed to pay back any money earned over the contract price were energy prices to rocket, whilst requiring a subsidy all the time the contract prices remained above the wholesale price.  The grid operator also had to hold capacity auctions, offering money to owners of stand by plants that would work in periods of low wind or little solar to keep their capacity ready to run. As they hoped these plants were not going to run that often they needed to offer sufficient money to make it worthwhile maintaining , staffing and fuelling the plants ready to run. Gas plants ended up running a lot to keep the system going with more than half our electricity coming from gas on a typical light wind day.

The consultation document does not give a clear steer of what would be a better system to guarantee security of supply whilst also providing plenty of competitive pressure to keep prices under control. The original regulatory system set up by the UK in the 1980s before the EU took over was a simple one of generators bidding into the system their price offers. The grid  manager always took the next cheapest offer when having to scale up the output, and dropped off the dearest when cutting supply. The system was sufficiently attractive for there to be spare capacity so we never ran out of power even on cold dark windless busy day. Most of the power came from coal and gas, with a useful contribution from nuclear.

The immediate issues are the way some providers of renewable power can receive the elevated gas based price despite having much lower costs, and the lack of margin in our capacity for when the wind does not blow and the sun does not shine. The UK has also to prepare for a reduction in output from nuclear this decade, which is planned to see the closure of all but one of the existing nuclear stations. What are your thoughts on the changes we need?

The Liz Truss team have said they want to ease the energy squeeze. They like the ideas of lower taxes and the removal of needless or excessively costly regulation. Energy would be a good place to start.

Let us consider first of all the £16bn or more cost of fitting a smart meter in every home for electricity. Indeed total roll out may well cost more, given the reluctance of almost half the population to have one and the troubles with how the early ones worked. The idea is to charge the mounting costs to all bill payers.

Whilst electricity is this dear why not pause the programme? By all means fit one where the householder is keen and applies willingly for one, but save all the promotional money and conversion costs where people need to be talked into it.

Then there are the green levies. It is a good idea to cease charging these direct to bill payers for a bit. More importantly going forward the grid controllers should only sign contracts for renewables that can deliver affordable energy without subsidy. This should be easy at current gas prices.

Large scale energy  intensive industry has to buy carbon permits over an initial and reducing free  allowance. Designed to cut fossil fuel use by industry, it can end up closing plants in the U.K. only to import more from abroad. The imports will often generate more CO2 than relying on domestic production given transport costs and more reliance on coal in China and Germany. So why not suspend this scheme whilst  U.K. energy prices remain so elevated? How many high energy using businesses will we lose if we carry on with dear gas and carbon penalties?