The historical role of energy in UK inflation and productivity and implications for price inflation in 2022

Working paper

We model UK price and wage inflation, productivity and unemployment over a century and a half of data, selecting dynamics, relevant variables, non-linearities and location and trend shifts us¬ing indicator saturation estimation. The four congruent econometric equations highlight complex interacting empirical relations. The production function reveals a major role for energy inputs ad-ditional to capital and labour, and although the price inflation equation shows a small direct impact of energy prices, the substantial rise in oil and gas prices seen by mid-2022 contribute half of the increase in price inflation. We find empirical evidence for non-linear adjustments of real wages to inflation: a wage-price spiral kicks in when inflation exceeds about 6–8% p.a. We also find an addi-tional non-linear reaction to unemployment, consistent with involuntary unemployment. A reduction in energy availability simultaneously reduces output and exacerbates inflation.

Authors: Castle, JL; Hendry, DF; Martinez, AB

• Publication status: Published
• Publisher: University of Oxford
• Series: Department of Economics Discussion Paper Series
• Publication date: 2022-09-07
• Paper number: 983
• Language: English
• Keywords: location shifts; equilibrium correction; indicator saturation estimation; energy; inflation