With chancellor Rishi Sunak set to present his budget in under a fortnight, we can expect no shortage of commentary about the dangers of public spending and the need to be ‘responsible’ with the nation’s finances. For austerian fearmongers, however, there is a new kid on the block—or rather one old enough that some readers may not remember it. Alongside the hazards of spiralling debt, we are told, we also face the spectre of inflation. Among those raising the alarm is Labour MP Wes Streeting, who recently warned of ‘a wage-price spiral that risks fuelling inflation’.

Streeting was quoting libertarian think tank the Adam Smith Institute, who were, somewhat ironically, invoking a theory of inflation which originates with Marxist thinkers. The ‘conflicting claims’ theory regards inflation as the outcome of class conflict: when workers are in a position to demand pay rises—because of union strength and capacity to strike—firms may respond by hiking prices in an attempt to preserve profit margins.

The theory does a good job of explaining the inflation of the 1970s. Organised labour was strong and could take action to force wages increases, squeezing corporate profits. Sharp increases in oil prices and the break-up of the ‘Bretton Woods’ system of managed exchange rates triggered accelerating tit-for-tat wage and price increases: a wage-price spiral.

The theory makes quite different predictions about the contemporary situation. Strong unions and strike-ready workforces have been replaced by precarious employment, zero hours contracts and single parents working multiple jobs to make ends meet. And while there are currently record numbers of unfilled vacancies in sectors such as hospitality, this reflects the dislocation of lockdown followed by reopening. Employment has not yet recovered to pre-pandemic levels, and we have yet to see the effects of the furlough scheme ending. The overall picture does not suggest a seller’s market for labour; a 70s-style wage-price spiral is not a realistic prospect.

A competing explanation of inflation—widely accepted in academia and in central banks—regards price increases as the result of ‘too much money chasing too few goods’. Historically this was thought to be the result of excess money issuance by the government or central banks. More recent versions of the theory instead frame the issue as money being too cheap: inflation is regarded as the result of low interest rates and easy availability of credit. The conventional solution is therefore to raise interest rates. Already there are signs that the Bank of England is preparing for rate hikes.

But this story is no more plausible than the wage-price spiral story as an account of current price increases. Credit has been loose for over a decade: interest rates were cut to nearly zero following the 2008 financial crisis and have stayed there ever since. Although quantitative easing increased substantially during the pandemic there has been no recent substantial loosening of monetary conditions. Nor is there any reason to believe that credit growth is driving price increases.

Instead, price moves are being driven by the reopening of economies around the world as the pandemic eases in rich countries. With surging demand for goods, global supply lines are stretched to the limit, leading to surging prices. A whole host of factors have combined to drive energy prices, gas in particular, sharply higher. While these trends are global, they are exacerbated in the UK by the disruption caused by Brexit.

These price rises will hurt: bills for food, heating and transport will become unmanageable for many, exacerbated by the needless cruelty of the cut to Universal Credit. For millions of people, living standards face the sharpest squeeze in decades.

Talk of rate hikes or wage-price spirals miss the point. Higher interest rates will translate into higher mortgage costs for families who are already feeling the pain of higher prices, and will raise costs for businesses. They will do little to counteract price rises driven by bottlenecks and energy shortages, but are likely to weaken the economic recovery and raise unemployment.

Current moderate increases in average wages are a welcome change in trend, not a sign of an impending inflationary spiral. Average wages have only just recovered from the 2008 crisis. The last decade has been the worst for wage growth since at least World War II. Corporate profit margins can and should absorb an increase in wages.

The correct reaction to the current situation is to look to the root cause of shortages and bottlenecks: decades of underinvestment in infrastructure, R&D and manufacturing, alongside reliance on fragile global production and distribution chains. Rather than cuts to government spending and rate hikes, the appropriate policy response is to raise investment aimed at the transition to net zero.

This will reduce reliance on volatile gas supplies and generate good jobs for thousands of workers. Social safety nets should be strengthened not weakened. Loose talk about ‘levelling up’ should be replaced by a genuine strategy to reduce regional inequality and mend our creaking transport system. Instead of using the social care crisis as an excuse for regressive tax rises, genuine action is needed.

Inflation is the symptom, not the disease. It should be treated accordingly.