The historical role of energy in UK inflation and productivity with implications for price inflation
Jennifer L. Castle, David F. Hendry, Andrew B. Martinez
Abstract
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 using indicator saturation estimation. The four congruent econometric equations highlight complex interacting empirical relations. The production function reveals a major role for energy inputs additional 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 additional non-linear reaction to unemployment, consistent with involuntary unemployment. A reduction in energy availability simultaneously reduces output and exacerbates inflation.