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Why freezing energy prices will help stop economic catastrophe

Nationalising the big five energy firms is no panacea for the cost-of-living crisis.

By Jeevun Sandher

Dramatically rising energy prices represent more than a crisis for the UK: they are a catastrophe. As things stand today, half of us are already cutting back on food, 45 per cent of us are struggling to pay their energy bills, and the economy has begun to shrink. That is where we are now when the energy price cap stands at £1,971. 

Now imagine what happens if we let the energy price cap hit £4,266 this winter. Even middle-class families will go to the wall while those on the lowest incomes will be pushed even further into starvation and destitution. The economy is likely to enter one of the most damaging recessions of the modern era. 

This week, Labour leader Keir Starmer set out his party’s proposals to deal with the “national economic emergency” of the cost-of-living crisis. Labour’s plan includes freezing the energy price cap, which, as I and my co-authors at the IPPR think tank have shown, will help to protect families and the British economy from a very difficult winter and its devastating aftermath. 

Let’s start with why we need an energy price cap in the first place. If energy bills rise by over £2,000 that will hit middle-class families as well. The average family takes home about £40,000 after tax – they don’t have an extra £2,000 just lying around. We should also raise Universal and Pension Credit to help low-income families, but we should not forget those in the middle and even upper-middle classes that will struggle to pay higher bills. 

Tax cuts, as both Conservative candidates for prime minister have proposed, just wont cut it. The National Insurance tax cuts being offered by Liz Truss will do nothing to help the poorest families, give only crumbs to middle-income families worth £110, and give the richest 5 per cent about £2,000.  

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There have also been calls to take the big five energy firms into public ownership. There are good arguments for doing so, including the enormous profits they are seeing now their competitors have gone bust. However, even if we nationalise these companies, the government would still need to find funds for an energy price freeze. That’s because the main driver of higher energy bills across Europe are the global gas prices that have risen five-fold since the beginning of 2021. For energy bills to be lower, the government would need to fund the difference between higher global prices and the amount we pay to a publicly owned energy provider each month.

Beyond the immediate effect of helping families to pay the bills, an energy price freeze will also help stop the often heard but rarely explained “wage-price spiral” that would be deeply damaging for our economy. 

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Here is how a wage price spiral works in practice. In normal times, UK workers expect inflation to be about 2 per cent. That is, not coincidentally, the Bank of England’s inflation target. As workers know that prices will rise by roughly 2 per cent, they use that as a factor in their own wage demands. The wage rises workers actually receive does, of course, also depend on their bargaining power. 

But in a wage-price spiral, prices rise so rapidly that workers don’t know what to expect inflation to be in the future. They rightly ask for higher wages to try and meet their own increased cost of living. When workers have bargaining power, such as when unemployment is low, then firms must try to meet those wage demands to retain staff. Firms then need to raise their own prices to cover higher costs. This leads to another round of increasing wage demands and higher prices. Higher prices lead to higher wage demands, leading to higher prices, leading to higher wage demands. That is the spiral. 

A wage-price spiral is so damaging because it leads to inflation becoming embedded in the economy. That not only makes us all poorer today, it also requires rapid interest rate rises and a painful recession to bring down inflation in the future. 

The energy price cap freeze will help stop a wage-price spiral taking hold. Freezing the price cap at its current level will directly lower inflation by 4 per cent. By directly lowering prices today, we are also making it easier for workers to predict future inflation. It also makes today’s inflation more likely to be temporary and less likely to become embedded in future expectations. In addition, lower inflation will raise family incomes today, leading to more spending and a lower risk of recession. 

There have been some criticisms of this policy. The first objection is how to fund it. Labour’s £30bn plan for a six-month freeze, announced this week, is fully costed. I would recommend going further and keeping it in place for 12 months, which would require an extra £30bn. This can easily be found. At least £20bn can be found by reforming capital gains tax, implementing a financial transaction tax, and a mansion tax, as well as extending the windfall tax. The final £10bn can be found from lower debt interest payments and taxing the huge increase in billionaire wealth over the past year.  

The second, more serious criticism, is the length of time this policy takes. What if we fund a one-year freeze, as I favour, and then end up in the same situation next year if prices remain high? That is why it is crucial to use the next year to insulate homes and drive down our energy costs. We can’t wait a year hoping that prices may fall. We must plan for a world in which they don’t. 

A third criticism is that freezing energy prices will stop the price mechanism reflecting the fact that natural gas is more expensive and reduce incentives for households to switch to renewable sources. However, households have already seen their energy prices rise by 73 per cent over the past 18 months. They have a strong incentive to switch, but they just can’t afford to when it costs £6,500 to install solar panels.

Freezing energy prices is an extraordinary measure, but these are extraordinary times. If energy prices are allowed to rise by over £2,000 this winter, it will lead to destitution for British families with a devastating recession to follow, which comes after a decade of stagnation. Freezing energy prices will help British families survive the winter – and raise economic growth to boot.

[See also: Liz Truss finally unveils plan to freeze energy bills this winter]

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