By Tracey Varnava, University of Southampton

This month’s sharp fall in the inflation rate will bring cautious hope to a government focused on its mission to slay the inflation dragon.

All eyes are on the annual rate of CPI inflation, whose reduction up to this week has been disappointingly slow. At 7.9%, it’s just over 3 points below its peak of 11.1%, but needs to fall nearly twice as much again to reach the official target of 2%. But should we be fixating on this this annual rate, as if once it comes down, the damage of inflation will have been undone? When it comes to the impact on living standards, nothing could be further from the case.

The long-term trend in median household incomes is incredibly bleak. In the last two decades of the 20th century, they rose on average by 2.5% a year (after inflation), which we came to see as the norm. But this rate fell to 1.5% in the 2000s and 1% in the 2010s, while zero real income growth in the present decade looks like a real prospect. With inflation outstripping wages growth, real earnings are currently going backwards. The overall effect of this on living standards in the 20s depends not just on the annual rate at any point in time, but on the cumulative amount that prices will have risen, compared to cumulative income growth over the same period.

The key inflation statistic that should be reported is this:  since prices started to take off in 2021, the Consumer Prices Index has risen by a total of 20%.

Average earnings in this period have risen by 14% across the economy, and by 8% in the public sector, equating to a real-terms fall in public pay of 10%.  Recently-announced public sector pay increases of 6 or 7 % next April, by when prices will have risen further, will not reverse this.

Looking at the cumulative effect of inflation in this way is appropriate today because of two distinctive characteristics of current inflation contrasting from that of the 1970s and 80s. First, inflation has come suddenly rather than building up over time and second, it was more common then to index pay to prices as a starting point in wage negotiations. The hope today is that by not doing so, inflation will be nipped in the bud, but the consequence will be a one-time hit on living standards. Cumulative inflation compared to cumulative pay increases in this period will tell us the size of this hit.

It’s worth in this context reminding ourselves just how steeply prices have risen since January 2021, in contrast to the preceding period.

While overall prices increased 20% in the two years and four months since then, in the preceding eight years they had grown by only 12%. And while food prices are now a scary 29% higher than in January 2021, over the previous seven years they had not changed at all (or rather had initially fallen slightly, then risen slightly).

If wage restraint can indeed help make this extraordinarily abrupt period of high inflation end almost as briskly as it began, there’s a prospect of limiting the long-term impact on living standards to less than it would have been if higher wage increases triggered a lengthy inflationary period. But as real-term pay cuts for millions of workers move into their second or third year, the total impact on living standards greatly outstrips what is implied by comparing annual rates. We should therefore be looking at the magnitude of the living standards crisis in terms of people’s real incomes now compared to early 2021, and considering if their intentional reduction is really proving effective in limiting the degree to which workers are eventually left worse off.