It’s understandable, faced with this extraordinary squeeze, that people and firms in the UK economy have sought to protect their real incomes – whether pay or profits – through compensating rises in wages and domestic prices. Unfortunately, and at least collectively, those efforts will not make us better off. It’s not as if one group or sector is worse off only because another, within the (non-North Sea) UK, is better off. The rise in import costs has depressed the purchasing power of the country as a whole. So all that can be done is to shift the losses from one place to another. And in the process, without any lasting impact on real incomes, the result is simply higher growth of nominal pay and prices. These are the “second-round effects” (of higher import prices on domestic inflation) to which monetary policy is having to respond. Today, I want to make three points about this process. First, monetary policy cannot undo the hit to real income. Nor could it ever have done. One often hears that people are worse off “because of inflation”. This is not quite right. Implicitly, it presumes that monetary policy could have prevented prices from rising so fast without doing anything to nominal incomes. Unfortunately, that’s not the case. Even assuming policy had been tightened sufficiently aggressively, and sufficiently early, to have knocked eight percentage points off the current rate of inflation, it would also have depressed nominal income growth by at least as much and almost certainly quite a bit more.
Bank of England  Page 1  The inflationary consequences of real shocks − speech by Ben Broadbent Given at Imperial College, London 20 October 2022  Bank of England  Page 2  Speech Introduction and summary Between them, the Covid-19 pandemic and Russia’s invasion of Ukraine have inflicted significant damage on the UK’s national income. Today I want to look at the link between these extraordinary shocks, the very high rates of inflation that have followed and the response of monetary policy. I will also draw one particular contrast with the potential response to easier fiscal policy. I’ll kick off with the slightly less dramatic topic of national accounting identities. One of the first things you get taught in macro-economics is that national income is equal to national output: in principle GDP measures both these things, as well as aggregate demand. Accounting identities of this sort don’t tell you anything about what causes what as they’re true by definition (though it’s useful to understand that we earn only what we produce and sell). But you might at least think, given the recovery in whole-economy output in the eighteen months since (Chart 1), that the worst of the drops in national income during the pandemic are well behind us.