Understanding UK Inflation

In a nutshell

The common explanation for inflation is that the government spends ‘too much money’, creating excess demand that pushes up prices. However, the recent UK inflation crisis of 2021-2022 shows this isn’t the main story. Inflation spiked because supply chain disruptions, energy price shocks from the Ukraine war, and corporate pricing decisions, not government spending. Indeed, all the major inflation episodes since WW2 in the UK have originated from the supply-side of the economy, particularly the fossil fuel energy sector.

The full explanation

Understanding inflation requires looking beyond simple “money supply” explanations to examine what actually drives price increases in the real economy.

Supply-Side Inflation: The 2021-2022 inflation surge began with supply breakdowns during the COVID-19 recovery, then worsened dramatically with energy price spikes following Russia’s invasion of Ukraine. Food and energy costs rose not because there was “too much money chasing goods,” but because there were literally fewer goods available and higher production costs.
Resource Constraints, Not Money Constraints: The economy’s true limit isn’t the amount of money in circulation, but available real resources. For example, if the government tries to buy more healthcare workers by raising wages when there’s already full employment of nurses and doctors, wages will rise as private sector employers compete for limited staff.
Corporate Pricing Power: Many price increases during recent inflation periods resulted from corporate decisions. As supply restraints caused a temporary rise in prices, many companies used supply disruptions as cover to raise prices beyond their increased costs. This “greedflation” or “seller’s inflation” demonstrates that market concentration and pricing power often drives price changes.
Energy as a Special Case: Energy costs ripple through the entire economy because energy is an input to virtually everything we produce. When global energy prices spike, as they did in 2022, this drives up costs across all sectors regardless of domestic monetary policy.

Frequently Asked Questions (FAQ)

But didn’t the government’s COVID spending cause inflation? The timing doesn’t support this. Government spending peaked in 2020-2021, but inflation only became problematic in late 2021 and 2022, coinciding with supply chain issues and energy price shocks. Many countries with very different fiscal responses experienced similar inflation patterns, suggesting common global supply-side causes.
Doesn’t printing money always cause inflation? The money supply increasing is an effect, not a cause of price rises. Inflation usually starts in the energy sector, prices rise and the money supply rises to allow the economy to function at a higher price level. A good way of thinking about this is by considering car travel and fuel consumption. If people decide to travel more by car, fuel consumption rises to accommodate this. The extra fuel consumption is the effect not the cause of the extra travel. When there are shortages, firms raise prices and the money supply rises to allow the economy to function. If it didn’t the economy would grind to a halt.
How can the government control inflation if it’s not just about money supply? The government has several tools: targeted taxation can reduce demand in overheated sectors and should be part of the government’s budget planning (not an after-the-fact response); reducing its own spending frees up resources for others; and public investment can increase productive capacity over time. Most importantly, fiscal policy (taxes and spending) can be much more precise than interest rates, which affect the entire economy. A buffer stock of employed labour in the form of a Job Guarantee (see other resources) provides a price anchor that reduces inflationary pressure. The government should identify the key source of inflation as the fossil fuel sector. By investing in green energy production now, it insulates the UK from future inflation originating in higher oil and gas prices.
Can’t we just leave it to the Bank of England to control inflation with interest rates? Relying only on interest rates is a very blunt and ineffective approach. To curb inflation, the Bank of England has to raise rates high enough to slow down the entire economy, and in the current situation higher interest rates, certainly in the normal range, are just as likely (if not more so) to be inflationary. That’s because of the government debt to income ratio, which is very high. A higher interest rate means much higher interest income for bond holders, which increases spending power by more than the negative effects of higher interest rates on loans.
What about the 1970s inflation crisis? Wasn’t that caused by too much government spending? The 1970s inflation was primarily driven by oil price shocks (the oil crises of 1973 and 1979), not excessive government spending. When energy costs quadrupled, it rippled through the entire economy. The lesson is that inflation often originates from supply-side shocks in critical sectors, not from general “excess demand”.
This seems to ignore basic supply and demand. If there’s more money, won’t prices go up? This is a cause and effect. Economists use the term ‘endogenous’ for the money supply. Price rises cause the money supply to rise, not the other way around. It is possible that ‘money creation’ could cause inflation if it pushes demand beyond what the economy can produce. But in the UK, for example, excess money creation has never been a primary cause of inflation in the post-war period. In the 1980s, a group of economists called monetarists argued that increases in the money supply caused inflation in the UK. However, the ideas of this group have been proved wrong over and over again. They just refuse to go away!
How does this explain why some countries have much higher inflation than others? Countries with weaker productive capacity, dependence on imports, or institutional problems managing resource allocation tend to hit inflationary constraints at lower spending levels.