Analysing the impact of high inflation on the cost of living

It is impossible to pick up a newspaper these days without reading about the cost of living crisis and skyrocketing inflation. In this article, we will dissect the inflation data and look at how problematic inflation really is.

Who is most affected by inflation?

Inflation isn’t fair, and that’s why it’s as much a political issue as it is a central bank issue.

The current inflationary wave we are experiencing disproportionately affects low-income households because it is a wave of cost-push inflation, meaning that the rise in energy prices has spread beyond energy to basic necessities such as food and shelter.

If you are lucky enough to be a middle or high-earner, you may worry about an increase in school fees or mortgage payments. However, the impact on energy and food is much more pronounced, and that’s why governments have intervened to make the stress on low earners slightly more bearable with measures such as the energy-price cap.

However, many argue that not enough is being done at a policy level and, for example, homelessness has risen dramatically due to the cost-of-living crisis wave and associated inadequate protection for the lowest earners.

Fighting inflation by monetary means alone might not be an immediate success

‘Cost-push’ inflation is something that central bankers cannot directly influence: by raising interest rates, they can try to dampen aggregate demand primarily from the middle class and high earners, for example, by making mortgages more expensive and forcing high earners to cut back on discretionary spending.

But they can’t directly affect the prices of basic goods. These are largely dependent on energy prices and international markets, so the expectation is that inflation will stay with us for longer and higher rates will as well.

Which items have risen the most in price, and what is the outlook?

Unsurprisingly for most people, energy, food, shelter and education have seen the biggest price rises in recent years. However, there are also many disinflationary trends in all these areas that could help to reduce inflation in the coming years.

Energy

As we know, energy prices exploded after Russia’s invasion of Ukraine. However, the inflationary effect has subsided, and energy prices are now largely back to levels lower than before the war.

It is due to the success of energy-saving measures, with EU electricity demand falling by 3.5 per cent, a remarkable drop in energy demand only surpassed by the Covid recession in 2020 and the financial crisis in 2008.

In addition, political measures such as the oil price cap on Russian oil have led to a permanent discount on Russian Urals oil, which is still purchased in Asia, but at a larger discount, leading to disinflationary effects in those countries.

As envisioned by think tank RethinkX, in their energy outlook for this decade, we are likely to see a large uptake of renewable energy, which has already undercut electricity generation from fossil fuels in price: a disinflationary effect is highly likely once the immediate energy shortages caused by the war and Russian sanctions have subsided.

Food

Food prices have shot up by more than 17 per cent in the latest U.K. inflation report. As the main inputs into food production are labour and energy, this is not surprising. Food is possibly the key item where inflation will stay high for a considerable time to come.

However, until recently, food prices have fallen relative to wages in recent years due to the growth of industrial agriculture and associated exploitation of food industry workers and wage dumping, something which is not often discussed but is an increasing problem in Europe.

As a result, reforms in labour laws, such as the EU’s ‘forced labour’ regulations, and a shift towards sustainability and away from factory farming and other exploitative means of food production are now beginning.

Fortunately, new technologies in protein production are likely to have a significant deflationary effect on food prices in the coming years.

Shelter

Rent inflation has actually lagged behind the average CPI in the UK and Europe. This isn’t surprising, as rent inflation was already strong before the cost-of-living crisis started.

Rents are affected by supply and demand, and most of the lower-income population rents. Hence, landlords are likely lacking the ability to demand that rents rise in line with inflation.

Education

Private education and university fees have seen one of the key price increases of inflation over the past decade. High-quality education is seen as a guarantee of a high income, and people were willing to pay ever higher fees, with student loans readily available.

However, with student loan costs rising, people are planning more carefully. In addition, new models of education are also making the rounds, such as Eugene Blair’s startup Multiverse shows. Instead of expensive education, it is possible to get on-the-job training through tailored apprenticeships.

Outlook

High inflation is an undeniable reality, disproportionately affecting lower-income households and significantly impacting the cost of living.

The key areas of food, energy and shelter have been most affected and it is widely expected that the current wave of inflation is likely to continue for longer.

Nevertheless, there is some optimism for the future as the effects of energy-saving measures, policies, and technologies become more widespread, which will likely have disinflationary effects in the longer term.