Why inflation does not bother Boris Johnson too much

After Brexit, the UK seems to be jumping randomly from one crisis to the next, and the government seems strangely unperturbed by the general distress.

Partly, this can be attributed to the politicians’ own failure to learn. Prime Minister Boris Johnson has proven again and again that he is prone to repeating past mistakes — the way he handled the multiple lockdowns in the Covid-19 crisis is the best example of this.

But what if at least part of it is deliberate? There could be a couple of reasons for which crises suit Johnson and his government very well, at least for a while.

First, things like shortages of fuel and other essentials take people’s minds away from the government’s day-to-day activity (as long as the government isn’t blamed for the shortages, which seems to be the case for the moment).

The government can therefore try to push through unpopular or even undemocratic legislative measures with less scrutiny or opposition than in normal times.

The second reason for which the government would welcome inflation taking off is less obvious, but no less important: rising inflation erodes debt. And the UK government has borrowed a lot.

UK government debt was £2,224.5 billion in the financial year ending March 2021, according to the most recent data from the Office for National Statistics. This amounts to 106% of gross domestic product (GDP). The budget deficit was an eye-popping 14.5% of GDP.

It is true that during the pandemic the government had to borrow money to help the people: many businesses were closed to prevent the spreading of Covid-19 and their employees had to be kept on furlough. This spending came on top of an already-rising public debt.

There had been little alarm in financial markets on the potential negative effects of this debt because interest rates have been at historically low levels. However, they may soon start to rise, throwing the issue in sharp focus.

What do you prefer: shortages or inflation?
Photo taken in April 2020.

The government knows that the Bank of England – which has warned about 4% inflation, double its official target and above August’s 3% — cannot risk crashing the housing market and therefore the economy by hiking its interest rate too much from its historically low 0.1%.

Cutting the debt as if by magic

A deeply negative real interest rate acts like a sponge on the public debt because the holders of UK bonds, or gilts as they are known, end up nursing losses on their holdings. But at least the government’s debt burden is reduced as if by magic.

This could be some of the thinking behind Boris Johnson’s refusal to allow more work permits for foreigners to cover the shortages of labour that have developed since the summer. Higher wages will spiral into higher inflation, which would suit the government just fine for a while.

But it is a very risky strategy, which could backfire spectacularly. None other than Brexit supporter Lord Simon Wolfson, the chief executive of Next, warned in a recent ITV interview: “If you just have more money chasing exactly the same numbers of people then there’s only one way to pay for that and that is with prices.”

“And we are beginning to see inflation creep into the economy. I hope it doesn’t lead to a 1970s style inflation spiral but if people believe that you can just increase wages and it will have no effect on prices then they are kidding themselves.

We all know that raising prices to increase wages doesn’t make anyone any richer, it leads to an inflationary spiral which is really dangerous.”

The government’s game seems to be to increase inflation by pretending to give people what they supposedly want, namely less immigration.

And when people protest over falling standards of living? Boris Johnson’s reply will probably be: That’s what you voted for.