The Case for Abundance: Why Demand Suppression Won't Fix the Cost of Living

The cost of living is frequently cited as one of the top concerns of British households. Accordingly, and rightly, it is one of the top priorities of policymakers and this Government.

Recent years have seen dramatic increases in the prices of basic goods (such as housing, food, energy and childcare) in absolute terms. The rise in prices of basic goods has outpaced that of 'luxuries' (such as electronic goods, holidays and clothing, which have in many cases become more affordable).

It is tempting to think of concerns about cost of living solely in terms of overall inflation, and therefore addressable through interventions to reduce inflation and/or increase wages through economic growth.

However, evidence around the demand elasticity of different goods implies that composition of inflation matters. Households feel quite differently about inflation of necessities versus luxuries.

The higher cost of necessities has a disproportionate impact on lower income households, who are forced to spend a greater proportion of their income on necessities, and results in a greater welfare loss than a comparable increase in the price of luxuries.

The importance of inflation composition implies that policymakers should devote comparatively more attention to the availability of basic necessities, such as housing, energy and childcare.

This requires supply-side intervention, rather than demand-suppression to limit inflation. Dampening demand for necessities will only reduce living standards, especially as higher interest rates increase housing costs for mortgage-holders.

Addressing this will require radical policies to boost housing supply, support energy abundance, and increase transport capacity, among wider regulatory reforms to support Britain's productive potential.