In the Bleak Midwinter
Energy prices no longer contain any useful information.
At one point yesterday morning gas prices rose by 10%. Which, in cash terms, is roughly equivalent to pre-crisis cost of gas.
I’m an economist. I think price signals are useful. Two weeks ago, when discussing how governments should respond to rising energy bills on Radio 4 I gave the economist’s answer: let bills rise to keep the price signal whilst giving households lump sum payments to protect their incomes.
But a lot can change in two weeks.
Olly Bartum’s chart of gas pricing is terrifying.
We have reached the point when European gas pricing is conveying no more useful information. The message, at present, is crystal clear: there is a serious shortage of energy. You could double prices at this point and we would learn nothing new.
Plugging these sort of numbers into the usual formulas starts to give silly answers.
Cornwall Insight reckon they imply a domestic energy price cap of over £5,300 by Q2 next year. Citi have notched up their UK CPI forecast at 18.6%. I’m not questioning the maths behind either Cornwall’s or Citi’s calculations but I do not think either is at all politically tenable.
These sorts of numbers imply widespread poverty amongst households, a collapse in discretionary spending, utter ruin for many SMEs and a fair few larger firms too.
In reality the government will not stand idly by and let this happen. The domestic energy price cap will not be allowed to reach £5,000. Firms will receive support with their bills. Perhaps not as much as they need, but a substantial amount.
Liz Truss may be against ‘handouts’ but crises make for unusual outcomes. Gordon Brown, the co-creator of New Labour, found himself nationalising banks. Boris Johnson, perhaps Britain’s most libertarian inclined Prime Minister of modern times, found himself placing the nation under house arrest. Rishi Sunak was pushed into increasing the tax burden to its highest level in decades whilst constantly talking about his love of low taxes.
Liz Truss may be, by instinct, Britain’s most free marketeer PM since the 1980s but she will soon find herself capping prices, ignoring market signals and overseeing a large bailout of corporate Britain.
If energy prices stay at their current levels over the next couple of years, then government debt to GDP is heading for 120%. The only question is the route taken rather than the destination. Either the government can directly borrow the money to subsidise energy bills or it can let prices rip and see debt rise as one price of an even more gut wrenching recession.
A wide ranging support package to cap bills for households and firms has to be the realistic base case. The trickier decisions for the Truss government will come later and be even more unpleasant for them.
Dealing with the costs of high energy bills is going to mean a furlough-scheme type fiscal outlay. And with interest rates heading up the cost of servicing that debt is going to be higher too. The room for the kind of wide ranging, permanent tax cuts that Truss supports simply will not exist.
The second challenge will be even trickier for the Truss government. The government will have no option other than to suppress the price signal coming from the energy market. But capping prices is one thing, it does not (in the short term) deal with the reality that prices are rising for a reason: a genuine shortage of energy.
Once the government has accepted that it can’t allocate energy using a price mechanism, then the only option left will be energy rationing. The politics of that are going to be exceptionally difficult.
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But the logic here applies to all countries buying in the international markets, so won’t the prices continue to rise, to match governments’ willingness and ability to subsidise to their willingness to ration?