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Hello and thanks for watching this Life Solved short.

I'm Robyn Montague, and in these episodes, we get to meet the 1024�˹��� researchers who are sharing their work in the latest series of the Life So podcast.

And this is work that's changing our world for the better in all sorts of ways.

In this episode of the current season, which is going to be our final one, and as a post Christmas credit card bills start arriving,

we take a look at the ongoing financial challenges that are affecting us all in very different ways.

I'm joined by Dr Joe Cox and Dr Robert Gausden to understand interest rates, inflation,

and the different approaches that governments have taken around the world to help bring the cost of living crisis to an end.

Is there an end in sight?

Well, welcome both.

Thank you very much for joining me today.

So I think it's probably best to start with a few definitions, because I imagine not everyone understands in great detail what things like inflation mean, for instance.

But it's always in the news and in the media, especially recently.

So who would like to kick off with just giving us a couple of explainers?

Yes, I'm happy to do that, Robyn.

Now when people talk about inflation, what they mean more specifically is consumer price inflation.

And consumer price inflation is calculated by a statistical agency known as the office for National Statistics.

Now, the office for National Statistics undertakes surveys of households, and it conducts these surveys in an attempt to establish what households are spending their money on.

And having conducted these surveys, it creates a basket of representative goods and services.

And it works out the cost of this basket from one month to the next.

And it's particularly interested in how the cost of the basket is changing over a 12 month period.

It works out the percentage change, and that percentage change is known as the annual rate of price inflation.

Now, as you probably know, most recently back in November, the inflation rate was 3.9%.

That had come down from 4.6% in the October, and it was 6.7% in the September.

In fact, inflation have been as high as 11.1% in October 2022.

And that's essentially when people began to refer to a cost of living crisis.

So small amounts of inflation in an economy is quite normal.

And it's actually the sign of quite a healthy, well-functioning economy.

And indeed, you don't want prices to fall, because if prices are consistently falling over time, people will withhold their expenditure.

They'll wait till prices come down.

And that very action of withholding expenditure can slow the economy down and cause a recession.

So a small amount of price rises over time is actually something that's desirable.

It's when the figures get to double digits or really high levels that you start to encounter problems.

I really like the, the visual, um, aspect of using the basket to explain how inflation works.

I really like that.

But then how does interest interest rates plays into this?

Why are they significant when we're talking about inflation?

Interest rates are a method of controlling inflation.

And indeed the government a long time ago passed responsibility to the Bank of England for setting interest rates.

If we go back in time, you'll you're a young Robyn.

I'm less young.

Um, back in May 1997, we had the Labour Party elected as the government.

Tony Blair became the Prime Minister, Gordon Brown became the Chancellor.

The first decision that Gordon Brown took was to give operational independence to the Bank of England.

In other words, he gave the Bank of England control over the country's monetary policy.

What we mean by that is that the Bank of England was given control over managing interest rates in order to control inflation.

Now there's an inflation target.

The Bank of England has a monetary policy committee that meets to decide what is the appropriate rate of interest in order to meet that target.

Now, if inflation looks as though it's going to be higher than its target, the Monetary Policy Committee at the Bank of England tends to raise interest rates.

Now, the reason it would raise interest rates is that that would discourage borrowing and it would give an incentive to saving.

So if there's less encouragement to borrow and a greater incentive to save,

that reduces the spending of the public and with less demand for goods and services, that should put downward pressure on prices.

I think there was evidence that inflation was starting to creep into the system quite early on when we were coming out of the pandemic,

and I think the attitude of the Bank of England and other central banks around the world was that this was going to be a transitory period as the world readjusted.

To reopening after a Covid in the pandemic.

I remember at the time thinking, well I,

You know, that is quite a risky strategy because once inflation becomes baked into the economy,

once it starts to feature in people's expectations, then the actions of a firms of consumers starts to create inflationary pressure.

So you have to be quite careful not to allow inflation to creep up too high.

Um, and I think there was evidence that was beginning to happen, and the Bank of England didn't really take immediate action.

Then, of course, there was the war in Ukraine.

And suddenly that seemingly transitory increase in prices seemed to become much more pronounced and long lasting.

The inflation target is 2%.

But even before Russia's invasion of Ukraine, inflation in this country was around 4 or 5%, far too high.

And as Joe rightly says, the Bank of England perhaps was neglecting that excessive rate of price inflation.

He thought it was going to be purely transitory or temporary.

So it's been criticised for not acting sufficiently soon, and perhaps not raising interest rates to a sufficiently high level to combat the inflation.

But yeah, I think when you looked at the data from the UK, it raised a few eyebrows.

I think at the time of, you know, the bank continuing to have a very loose monetary policy,

making credit, very cheap, very easily available, when all the while, as Robert says, inflation was, was creeping well above the target.

So if my understanding of what you said when inflation is increasing, that's when interest rates also tend to increase to encourage saving.

However, after the Covid pandemic, um, we were actually all encouraged to spend to get out and, you know, visit restaurants.

Um, spend time with your friends and family, build the economy back up, but really once those inflation.

obviously, as a result, the inflation started rising, but the interest didn't account for that rise.

One one classic way of explaining inflation is it's too much money chasing too few goods.

I think that's exactly what happened when we came out of the pandemic.

Everybody or a lot of people were able to to save because what you weren't able to go out and spend money.

Um, and at the same time, everything reopened.

There were supply problems, shortages.

So you had this, this, this classic problem of too much money that built up over the pandemic, chasing too few goods.

And back in November 2021, the interest rate was this all was 0.1% historically low.

And um, subsequently the the Bank of England when it was more aware of the inflationary situation

made 14 consecutive rises in the rate of interest to try to combat this high inflation and that was deemed to have come from the war in Ukraine.

I'd say it was too late, because it takes time for interest rate changes to filter through into the economy.

So one thing that's always talked about with interest rate rises is how much more expensive mortgages become,

but a lot of mortgage borrowers or fixed term deals, they don't feel the interest rate increases right away.

It's only once the fixed term comes to an end after, say, 2 or 5 years typically, that those interest rate rises start to bite in terms of the high mortgage payments.

So there's a lag.

It takes time for the Bank of England's policy change to actually filter through into the reality of people's, um, pockets.

And I think, you know, on that basis, they took too long to introduce the interest rate rises

and were scrambling around then to make these consecutive rises once inflation had already become baked into the system.

Really.

And I'm I imagine how most people are I, I've experienced, you know, the hike as a result of the interest rate on mortgages.

Um, but what is the government doing,

and the Bank of England,

what can they do in order to discourage spending and hopefully get that back to a point, which is actually a good way of living,

because at the moment it feels like we are in a cost of living crisis.

And one of the things that tends to come up in conversation when that happens is a recession.

So how does a recession play into this narrative?

Technically, a recession is when you have two consecutive quarters of negative growth.

We measure growth typically using something called GDP gross domestic product, which measures the value of all the goods and services produced in the UK, typically in a year.

So if you have two consecutive quarters of negative growth, you enter a recession.

And I think that's what the Bank of England were conscious of when we were coming out of the pandemic,

that the economy had been faltering during the Covid years and didn't want to raise interest rates and bring about a recession.

They wanted to encourage more economic activity.

Um, and I think now we're looking at a situation where we may be facing, technically, a recession.

Uh, in the third quarter of 2023, GDP figures were revised to show they've been a small contraction in economic activity.

So within quarter four of 2023, it turns out that there was also a contraction.

We would technically be in recession.

Now, in some senses, that isn't as bad as it sounds, because really, the economy has been flatlining for a long time now.

And in some senses, if the economy's growing by 0.1 of a percent or shrinking by 0.1 of a percent, essentially it's staying pretty flat.

So in some senses, it's important not to get too concerned with a technical definition.

But at the same time, I think if we were to technically enter a recession.

I can foresee, you know, the media and the press, you know, being quite keen to advertise to, to to advertise that fact.

And once you are in a recession, it starts to affect people's behaviour.

You know, people may tighten their belts to see themselves through the recession period, and that action in itself brings about or worsens the recession.

So in a sense, when you say you're in a recession and people start believing, that brings about the conditions to, to to create a recession.

I mean, in a way, we get too obsessed with the term recession.

The fact is, the economy is not growing very fast.

There is a body known as the office for Budget Responsibility that pays attention to the government's finances, and it also makes forecasts.

And it predicted for the year 2023 that economic growth in this country would only be 0.6%.

And it's forecast for this year, 2024, and it's only going to grow by 0.7%.

Well, that is virtually nothing.

It suggests that the economy, as Joe said, is flatlining.

There is a lack of growth.

It doesn't really matter how it's distributed over the year.

You could have two consecutive quarters of negative growth, and then the next quarter could be very high growth.

And that would be a better situation than perhaps we've got at the moment, even if there's no recession.

But the fact is, in common with many other countries, our economy is not growing at a rapid rate.

If the economy is not growing at its rapid rate, then people's standards of livings are not improving,

and the government's going to be especially concerned in an election year, because to improve its prospects of being re-elected,

people have to have the perception of feeling better off.

And, you know, we've talked about quite a few external factors.

We've had the pandemic, you know, the war, Ukraine.

Have these been the main, if not the only, reasons while we're flatlining?

Or do you think there are other contributors?

Um, particularly to the UK.

The war in Ukraine is a very big factor in terms of determining the high rate of price inflation.

If you go back to April 2022, that was shortly after the invasion.

And as we know, President Putin restricted the supply of gas that had the effect of raising energy prices in this country by 54%.

And then later in the year, in October, there was another rise of 27%.

Those were enormous rises in inflation.

And the authorities say that the government or the Bank of England had to address this situation of very high price inflation.

So we're not saying necessarily that the war in Ukraine has caused a recession.

It's our response to the high inflation that is contributing towards the recession.

Now that that there will be other factors, but they really fade into insignificance in comparison to the effect of the war that's in Ukraine.

I think people have got used to during the pandemic years,

people got used to the security offered by government with furlough and various other schemes to stimulate the economy and prevent job losses.

People have started to get used to, I think, government stepping in to shield them from the worst of what the world has to offer.

Um, and that was the same when the cost of living crisis first hit, there were calls for government intervention, uh, payments to help supplement, you know, um, fuel bills and that kind of thing.

But I think there is a limit to how much governments can realistically step in and shield us from the bad things that happen in the world.

And as Robert said, you know, uh, uh, an invasion of a sovereign country, which then has such major ramifications on global markets is going to ultimately bite at some point.

It's going to affect living standards, and there's not a huge amount governments can really do to entirely remove that, uh.

Especially so soon after a global pandemic where the majority of the country weren't in work for months on end.

That's got to have a huge impact is so, you know, one thing after the other.

Absolutely.

And I dare I say it, but Brexit as well, I mean, we've got a large number of it's almost like a perfect storm in terms of the issues that are affecting prices.

And that is inevitably going to have an effect on people's standard of living.

And it would be a little bit naive to pretend that a government can intervene and step in and shield us all from that, because realistically, it.

You know, the government has to pay attention to international markets.

And if the government is spending a lot more than it's receiving in tax revenue, then the financial markets become very nervous.

And as we saw from that brief period when Liz Truss was the prime minister,

if you're seen to be spending and you're not sort of recouping very much in the way of your tax revenue, this causes a depreciation to occur.

As far as the pound is concerned, markets get very nervous.

And if there seem to be financial instability, this would tend to lead to very high interest rates.

We regard the current rate of interest of 5.25% as being relatively high.

But if you can't account for how you're spending, if there's no suggestion that you can raise the revenue to finance your spending, then you get rocketing high interest rates.

And that will be not only the cause of a recession, but something much deeper than that.

And, you know, speaking here about how well the the UK can react to, you know, international markets and spending,

it seems like quite apt that we're recording here in the School of Business at the University.

This is a Bloomberg Suite.

Um, and that's why we've chosen to record it here today, considering we're talking about money.

Um, there were countries though, when you look, you know, watch the news and you're on social media and things, you think, why are they doing okay?

Why does their economy seem to be more stable than the UK, especially when the UK is considered to be such a big player when it comes to things like banking and financial industry?

Well, I think all countries have been affected by this.

I don't think there's anywhere in the world that's been immune or shielded from what's happened in the last few years in terms of the pandemic,

in terms of the invasion of Ukraine, that's affected everybody.

But I think it is fair to say, if you compare us to similar economies like the G7, the largest seven economies in the world, we seem to have been slightly more affected by things.

Inflation has been higher in the UK than it has been in other G7 countries, and it's stayed higher for longer.

There's a lot of reasons why that is.

I think, you know, we're quite dependent on imports, particularly for things like energy.

Um, say it again, Brexit has inevitably had an effect on, on on that kind of thing.

And we also need to mention food prices.

Because not only have we had significant energy price inflation, we've had historically high food price inflation.

Again, that stems from the war in Ukraine and the fact that the UK is a relatively large importer of goods and services.

I think it's fair to say that a lot of the European countries have suffered almost to the same extent as the UK.

In America, they probably been a little bit more shielded from the the increase in the energy prices.

They're not so much reliant upon Russia that gets that supply from Russia.

So the inflation rate, the consumer price inflation rate has been lower in the United States.

If we've hit a peak of about 11%, that nearer to 8 or 9%.

So so far it sounds quite doom and gloom when we're talking about the cost of living crisis.

The UK were quite slow when it came to reacting to inflation rates.

We weren't really paying attention to the international market as much as we could have done.

But what sort of solutions are there to this?

You know, I've seen online a lot of people talking about increase wages as a way of potentially combating this.

Is that viable?

I can see why that's a popular opinion.

And the logic is there, I guess in some sense, is that the reason we're interested in inflation is partly to get a sense of how it's affecting standards of living.

So if incomes are rising more slowly than the prices of goods, it means the incomes we have won't buy as much as they did before.

So in real terms, our standard of living is declining.

So I, you know, and a possible solution is if you just pay people more thing comes rise, then you solve the problem.

But the difficulty with that is if people's incomes rise or you increase the wage level,

then that's increasing the costs that employers are having to face for their for their labour, for their employees.

So they will typically respond by increasing prices further.

So what you even though there might be a short term bounce from that in the long run,

what will happen is that prices will rise further to counteract that, and you start entering what's known as a wage price inflation spiral,

where wages go up, prices go up further, the wages go up further, their prices go up further.

Ultimately, our wealth and how well-off we are is is determined by the goods and services we produce and can consume.

And if if that's declining, then changes in wages and incomes aren't really going, isn't going to change that.

Yes.

Ultimately, if wage inflation continues to match price inflation, nobody is going to win.

Um, if wage inflation rises, this increases the costs of various employers.

Now you've got two different sectors in this country.

You've got a private sector and you've got a public sector.

If wages are rising at a phenomenal rates in the private sector, then the firms concerned may be keen to pass on those costs in the form of higher prices to consumers.

And as Joe mentioned, you get this wage price inflationary spiral in the public sector.

It's a little bit different.

Uh, what you tend to have in the public sector is different government departments with fixed budgets.

Of course, then if it's being necessary to pay higher wages to the employees, then you can't employ as many of them.

Or you have to raise taxes.

Or you've got to raise taxes.

And then, you know, that counteracts the effect of the higher wages.

Yes, yes that's right.

So in terms of the the gloomy predictions,

it's not all gloom because we can see inflation coming down and there are clear signals that inflation is coming down and will go down further.

If inflation comes down, interest rates will also be coming down.

We'll get a little bit more stability.

Of course, what we have to bear in mind, as it are, external factors.

You could say the main reason we've got a so-called cost of living crisis is because of an external factor, the invasion of Ukraine by Russia.

Now, sadly, there are often external factors that are going to come along and upset the economy.

So even if we can ride out this problem of the Russian invasion, we've now got another problem, possibly in the Red Sea.

Um, there's a lot of sort of nervous tension in the Red Sea.

This is affecting shipping.

Shipping may have to be diverted and take a long way around to transport goods.

And if the price of shipping rises, if insurance premiums rise, this is going to fuel a further bout of price inflation.

So this is the problem, um, that there are external factors.

If you go back in the past, the, uh, even higher rates of price inflation were experienced in the 1970s and the 1980s,

and they stemmed from significant increases in the price of oil.

And it's these external factors that tend to come along an upset, a stable economy.

And sadly, it takes a long while to recover from those external forces.

But I think if you're looking for good news, as things stand, it seems like we and other developed economies have turned a corner in terms of combating inflation.

So it seems like inflation rates have peaked and are coming down.

If that's the case, then central banks can look to lower interest rates.

And I think the markets are generally looking at that.

And the indications we're getting is that it's not a question of this, but when and how quickly interest rates are going to come down.

Depending on who you speak to economists or where you look at market data, it does seem to suggest markets are pricing in interest rate reductions over this year.

It's a case of when they might come in, um, perhaps the spring time.

But central banks are saying maybe that's too soon and they want to take a more cautious approach.

But I think we're looking at a situation where interest rates are inevitably going to come down at some point.

It's more a case of how quickly and when that's going to begin, uh, rather than if that's going to happen.

I think we've we passed the peak of interest rates.

So, uh, when we're going into the polls to do our votes, maybe take that in consideration, that tax cuts might not necessarily be what the country needs right now.

They sound great, but you've got to do as Robert says,

it's got to be fiscally responsible and introduced at the right time.

You know, if inflation is still trying to bring that under control and get it to the target level,

creating further inflationary pressure at this time probably isn't what the economy needs right now.

It's hard, as now, I suppose, when you know, you've a country is full of individuals all trying to, you know, make the most out of life and live to the full.

But if a country wants to thrive and continue thriving, it has to think of the many and not the few.

I think you have to take it,

and that's what we do as economists, is to try and take a broader perspective.

Of course, at an individual level, everyone would like to add higher wages for prices to come down, for taxes to come down.

But, you know, we live in the real world.

We live in a world of unlimited wants and scarce resources.

And so that core economic problem has to be managed.

And yes, I think everyone concerned wants to maximise living standards for as many people as possible.

But that isn't always easy.

And this the what seems like obvious solutions or attractive solutions to to voters actually possibly isn't in their long term interests.

So one does have to take a sort of broader view of things when making these kind of decisions.

Well, I think we need to mention that we have had so-called cost of living crisis in the past, and we have recovered from them.

I know you want a good news story, Robyn, so we're trying to give you this.

Um, if you do go back to the 1970s, in 1975, it was probably measured in a slightly different way, but price inflation was 24%.

It was still 18% in 1980.

As I mentioned earlier, that stemmed from very steep rises in the price of oil.

And in those days we were a very oil dependent economy.

We still are in a way, but we overcame that.

But there was a severe cost, uh, and the cost was very restrictive monetary and fiscal policy that was implemented by Margaret Thatcher's government.

Um, the cost of higher interest rates and reduced, uh, spending by, by the government was that we had a very long recession from memory.

It took about 13 quarters for GDP, gross domestic product to go back to its pre-recession level.

So it had an enormous recession.

And in those days that was associated with a very high rate of unemployment.

We had unemployment reaching almost 12%.

And, uh, in terms of numbers, that was in excess of 3 million.

Now, at the moment, the rate of unemployment is only between 4 and 5%, even though we're not enjoying very much economic growth.

So maybe we are coping a little bit better on this occasionally crises, and what history tells us is that we do eventually come out of a crisis.

And, uh, we had a long period in the 1990s, up to about 2007, when we were regularly having a decent amount of economic growth.

Certainly.

Then we got the financial crisis.

There's always something that comes along to trip up the economy, but if we're patient, then we can get out of this.

I think the only thing I'd add is to build on that.

Since the financial crisis, the UK has experienced a major issue of productivity.

And it's not.

That's not uncommon.

Other major economies have also seen productivity levels fall, but again, it seems to have been somewhat more pronounced in the UK.

And we're talking about standard of living improvements.

You know, entering into this price wage inflation spiral doesn't really increase standards of living, but increasing productivity does.

And productivity mean how much output each unit of labour each worker is able to produce.

And since the financial crisis, the increase we've seen in that level of productivity has slowed dramatically compared to the trend leading up to that point.

And the huge question marks as to why that is.

Um, it's called the productivity puzzle.

But I think if we're looking at ways in which we can actually enjoy better standards of living and get the economy growing

beyond this kind of anaemic flat line that we're we're seeing, we need to be looking at how to boost productivity.

Uh, I wouldn't even know where to begin.

And to be honest, I think the key takeaway from this conversation for me is patience.

I feel like we need to be patient to see the cost of living crisis come to an end.

It is, you know, the end is in sight.

It might take a bit longer than we'd like it to.

Patience for, you know, inflation to drop, interest rates to drop, patience for something like a plan of action for the future to actually take place, not just to have quick turnaround methods, we actually have to look long term, not short term.

Um, but it isn't all doom and gloom, like you said.

You know, there is a turning point now, um, there are ways that we can resolve it in the future.

It's just going to take a lot of thinking and some geniuses like yourselves to come to a solution.

Well, thank you both so much for joining me today.

It's been really interesting.

I hope our listeners have found interesting as well.

If you would like to listen to our full audio version of this episode of Life Solved exploring the cost of living crisis,

then please head to the 1024�˹��� website or download it on your favourite podcast app.

Now you can click the link in the comments box below or head to ports.ac.uk/lifesolved to find out more.

And that's the final episode of the series.

That's series 13.

We'll be back with series 14 of Life Solved very soon.

Goodbye.