Chart 1: GDP just about back to pre-pandemic levels  Level of GDP, 2019 Q4 = 100 104  104  100  100  96  96  92  92  88  88  84  84  80  80  76 Dec 19  Jun 20  Dec 20  Jun 21  Dec 21  76 Jun 22  Source: ONS and Bank calculations. However, while the accounting equality of output and income is valid in nominal (i.e. cash) terms, and more generally in closed economies, it’s not always the case in real terms and for open economies. When we’re able to trade with other countries we no longer have to  Bank of England  Page 3  consume and produce the same things. This means output and consumer prices can diverge. And movements in that relative price will affect the real consumption value of what we collectively produce even if its quantity (GDP) doesn’t change. If you produce apples but consume oranges you’ll be better off when the price of oranges falls (relative to that of apples), worse off if the opposite happens. It’s not that domestic output and productivity don’t matter for income: obviously they do. But movements in relative prices matter too, and there are times when they matter a lot. In the real-world UK economy, one of the big differences in this respect involves energy and other physical goods. Collectively we consume a lot more of these things than we produce.
The exact timing and scale of the peak rate of retail energy price inflation will obviously depend (amongst others) on the nature and duration of government support. But in the absence of further (and equally steep) rises in wholesale gas prices, and even without any such support, inflation in retail energy bills is likely to be materially lower a couple of years from now than it is today. Inflation in the areas most affected by the pandemic seems already to have peaked. However, it’s also because we are relatively unfamiliar with the second-round effects of these things. They very clearly existed in the past, before inflation targeting was put in place in 1992. Economists long recognised that, in the presence of “real income resistance”, negative shocks – from, say, higher import prices or higher taxes – could generate inflation in wages and domestic prices. Estimates of these effects using the historical data, from before the 1990s, were reasonably sizeable. But they then began to decline, a phenomenon many attributed to greater flexibility in the labour market. So although there were occasions after 1992 when real incomes were squeezed – the big rise in import prices immediately after the financial crisis was one obvious case, so too perhaps the period of weak productivity growth that followed – there was very little sign of any second-round response of domestic inflation. Absence of evidence is not the same as evidence of absence.