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The UK Cost of Living Crisis of 2022

The rate of inflation reached a staggering 11.1% (Hindustan Times, 2022), marking the highest level in the past 40 years. This alarming increase in inflation was accompanied by several other concerning economic indicators and events, including:


1. Depreciating currency.

2. Narrow escape from recession.

3. Cost of living crisis.

4. Increased electricity and gas bills.

5. Warnings from the International Monetary Fund (IMF).

6. Interventions from the central bank.

7. Complete economic policy U-turn.

8. Prime minister resigning in 45 days (Rajadhyaksha & Mavinkurve, 2022).



This leads to the question, “What happened to one of the world’s most stable economies, and how are they in this condition?". There are numerous factors that led them to this situation:


  • Interest rates- One of the worst recessions the UK ever had was in 2008, which lasted for 5 quarters. The major strategy the UK used then, was lowering the interest rates. They used Monetary policy, quantitative easing, and so reduced interest rates. This increases the incentive to borrow and also increases the money supply in the economy as more money is available for borrowing. More borrowing means, more investment, and more consumption, all increasing Aggregate Demand and thus promoting economic growth. These policies helped the UK get out of the crisis, however, this was a temporary solution, and the interest was supposed to come back to normal. Despite this, the interest rates kept falling until they were too low, in 2020 when the rates were 0.10% a historic low. The Government increased the interest rates massively last year, which increased the cost of borrowing. In August last year, the central bank increased the interest rates from 0.5% to 1.75%, and then to 2.25% in the next month, the highest it has been since 2008. In addition, they increased it to 3.00% in November(Think Plutus, 2023). As shown in the figure below (figure 1) (Trading Economics, 2023). This increase in interest rates was a sudden change and also decreased consumption and aggregate demand. The increase was done because of the massive increases in price, and to reduce demand-pull inflation, however, the problem was that the inflation was more cost-push rather than demand-pull. In addition, this increase in rates also adds to the cost of living crisis, as people had to pay higher house mortgage repayments. Nearly 4 million people had to pay a higher amount of mortgage repayments, as the average increase in repayments was £400, wiping out the savings of nearly 1.4 million people. (Aleynikova et al., 2023)

Figure 1 (Trading Economics, 2023)

  • Brexit- Ultimately, all the countries faced Covid, and a lot of countries were impacted by the Russia-Ukraine war, dealing with a shortage of oil, but why was Uk the worst impacted, the reason for this is Brexit. Before Brexit, a lot of the low-skilled labour in Europe used to migrate into the Uk, however after Brexit, a lot of the low-paying jobs experienced a labour shortage, there was a massive shortage of truck drivers, which led to fuel not being transported, which led to shortages in the gasoline industry, but it was not the only industry affected, the healthcare sector and the agricultural sector also experienced labour shortages, which increased the prices of food too, because of the reduced supply, overall worsening the cost of living crisis (Garrahan, 2022).


  • The new government- Liz Truss wanted to make drastic changes, and so she used Trickle-down economics, which means, helping the rich financially, which in theory will boost the economy, and so will help the poor. They put tax cuts in place and also the energy policy. This was criticized by the IMF and people called Fairytale economics. People lost faith in the government, as the poor people who were worst affected by the cost of living crisis, received no direct help from the government. Investors lost faith too and started to take their money out of the Uk economy and invested in other countries. This depreciated the pound against other countries, especially the dollar, causing the pound to go to an all-time low against the dollar. This increased the price of imports, as it was more expensive to buy foreign currency. This rose domestic inflation as a lot of imports are raw materials used to produce other goods. Again worsening the cost of living crisis. On the other hand, exports are supposed to rise, as it will be cheaper for other countries to buy Uk goods, however, exports were not affected, as the fall in price because of the exchange rate was offset by the rising prices, causing a current account deficit (Kwarteng, 2022).


  • The Russia-Ukraine War and Covid- During this time Russia completely cut-off gas, which shot up electricity and gas prices massively. In addition, the storage facilities were not very good, causing the supply to fall even more, to make everything worse, all of this was happening during winters, and the demand also rose. All of this together increased the prices (Prasad, 2022). Other than the war, Covid also resulted in massive labour shortages, supply shortages, and an increase in cost-push inflation.


  • The energy policy- The new government came up with an energy policy. They increased the cap by 175% and promised that the cap for energy prices will be the same for the next 2 years, regardless of the costs. Even if the costs go past the price cap, the suppliers should sell it at £520/MWh. If the costs increase above the price cap, the suppliers should offset their losses with loans from banks. The problem with this price cap is that, despite it offering stability and confidence to consumers, it is the same for all consumers regardless of their income. People with higher incomes spend less percentage of their income on electricity, than people with low incomes. As shown in the figure below. This is regressive in nature, especially also because the consumption is not capped and how you spend that energy. The Rich could spend it on luxuries, whereas the poor spend it on their necessities. Also because of the fixed market price cap, despite the rich being able to spend more on energy, and having a huge consumer surplus, they don't need to because of the price cap. This is very damaging, as the losses caused because of the rich, are either borne by the power companies or the government, this could have cost the government £180 billion. (Prasad, 2022)

Figure 2 (Bhattacharjee et al., 2022).


  • Bond crisis- Due to the energy policy, the government had to subsidize losses of the energy suppliers, also because of the tax cuts, the tax revenue was going to go down and the spending would rise, increasing the fiscal deficit. The way the government planned to get some money was through bonds. They increased the interest rates to make their bonds more attractive, and the yield on the 10-year bonds quadrupled, however, nobody still bought the government's bonds because of the exchange rate falling, which offset the incentive of the increasing interest rates. This is why the government failed to raise revenue through bonds and in the end had to rely on borrowing money from other governments (Prasad, 2022).


How is the Uk economy doing now?

Let's look at some of the economic factors looked at before and see how they are doing now-


Currency- The pound is doing very well in 2023 and is the best-performing G10 currency this year. There are 3 reasons for this. Firstly, overall investors prefer Rishi Sunak over Liz Truss, which is why it brought some confidence back in the economy. Secondly, interest rates were still rising in the Uk, and offered better interest rates than the US. although this increased the cost of living, it further drove investors to invest in the Uk banks, and finally, the Uk had hit rock bottom. The increase in the value of the pound is also because prior to this, the pound fell so low that there was only one way the pound could go (Michaelis, 2023).


Interest rates and bond yields- The interest rates however keep rising, which keeps worsening the housing crisis, but on the other hand also helped in the increase in the value of the pound. Moreover, the yield on the 10-year bonds has fallen a bit since September, and October last year, but in comparison to the pre-pandemic levels is still extremely high (Trading Economics, 2023).


Other economic factors- The growth in GDP was only 0.1% in the first 2 quarters of 2023 and was -0.1% in the 4rth Quarter of 2022. Compared to the pre-pandemic levels, Uk is the only economy in the G7 countries to be negative as shown in the figure below. Both IMF and OECD project the Uk to have the second lowest real GDP growth in 2023, only above Germany (Harari, 2023). Another positive is that inflation is falling. (As shown in Figure 4)

Figure 3 (Harari, 2023)



Figure 4 (Trading Economics, 2023)


Overall, the Uk economy has in no way recovered yet and is a mixed bag in terms of economic factors. The IMF predicted the Uk to have -0.6% growth in 2023 but now has soon changed its prediction to 0.4% growth overall, in addition, it had also successfully avoided recession. However, the Uk may be in a poisonous cycle of stagflation, where there is no economic growth but rising inflation (Murray, 2023).

















References-


UK inflation accelerates to 41-year high of 11.1% (2022) Hindustan Times. Available at: https://www.hindustantimes.com/business/uk-inflation-accelerates-to-41-year-high-of-111-101668598754534.html (Accessed: 08 August 2023).



Aleynikova, E. et al. (2023) Rising interest rates and higher mortgage repayments: What’s the impact on households?, NIESR. Available at: https://www.niesr.ac.uk/blog/rising-interest-rates-and-higher-mortgage-repayments-whats-impact-households (Accessed: 08 August 2023).



United Kingdom interest Rate2023 Data - 1971-2022 historical - 2024 forecast (no date) United Kingdom Interest Rate - 2023 Data - 1971-2022 Historical - 2024 Forecast. Available at: https://tradingeconomics.com/united-kingdom/interest-rate (Accessed: 08 August 2023).


(2022) The Brexit effect: how leaving the EU hit the UK | FT Film. Financial Times. Available at: https://youtu.be/wO2lWmgEK1Y (Accessed: 08 August 2023).


Plutus, T. (2023) UK interest rate history, Think Plutus. Available at: https://thinkplutus.com/uk-interest-rate-history/ (Accessed: 08 August 2023).


Kwarteng, K. (2022) The growth plan 2022. London: Stationary Office.


How UK committed Suicide with its Economy?: UK economic crisis Explained in simple words (2022) YouTube. Think School. Available at: https://youtu.be/OqKu8Lxnzro (Accessed: 08 August 2023).


Bhattacharjee, A., Mosley, M. and Pabst, A. (2022) A ‘variable energy price cap’ to help solve the cost-of ... - NIESR, National Institute of Economic and Social Research. Available at: https://www.niesr.ac.uk/wp-content/uploads/2022/09/A-Variable-Energy-Price-Cap.pdf (Accessed: 08 August 2023).


Michaelis, Z. (2023) Why the Pound is Having a (Surprisingly) Good 2023, YouTube. TLDR News. Available at: https://youtu.be/2CVOfzuqoY4 (Accessed: 09 August 2023).


Harari, D. (2023) GDP – international comparisons: Key economic indicators, GDP – International Comparisons: Key Economic Indicators. Available at: https://commonslibrary.parliament.uk/research-briefings/sn02784/ (Accessed: 09 August 2023).


Can one woman destroy Britain? | Truth about UK’s failing economy | Abhi and Niyu (2022) YouTube. Abhi and NIyu. Available at: https://youtu.be/A4w8qrug6X4 (Accessed: 09 August 2023).


United Kingdom inflation ratejuly 2023 data - 1989-2022 historical (2023) United Kingdom Inflation Rate - July 2023 Data - 1989-2022 Historical. Available at: https://tradingeconomics.com/united-kingdom/inflation-cpi (Accessed: 09 August 2023).


Murray, C. (2023) Has the British economy turned a corner?, Raconteur. Available at: https://www.raconteur.net/economy-trends/british-economy-impact-business-falling-behind (Accessed: 09 August 2023).


Citibank predicts 18.6% inflation for UK in January 2023 | UK’s cost of living crisis worsens | WION (2022) YouTube. WION. Available at: https://youtu.be/unNEYNzAbKw (Accessed: 09 August 2023).




































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