Energy shocks and inflation episodes in the UK

This paper explores the potential macroeconomic impacts of the recent episode of global energy shock in the UK economy. Unlike the Great Inflation in the 1970s, current inflation is likely to have limited impacts on the overall UK economy due to institutional changes, such as the weakening of collective wage bargaining, etc. As a result, we argue that the current episode of inflation requires limited interventions using monetary policies. A new macro-econometric forecasting model is developed for the UK economy to simulate counterfactual policy scenarios. •Modelling the Complex Impacts of High Energy Prices: The combination of post-pandemic effects and the war in Ukraine has led to high energy prices, impacting the economy. A comprehensive macro-econometric model (UKMOD) is constructed to study the complex transmission mechanisms in the UK economy under different scenarios of energy price movements.•The inflation modelling in UKMOD is focusing on three channels: consumption expenditure deflator, import prices, and private sector real wages. An energy price index, reflecting oil and gas price movements, is included in the equation to account for energy shock impacts. A simulation without energy shocks suggests that consumer prices would have been much lower during the early years of the global price spike. Inflation eventually stabilizes in both scenarios, but the economy suffers both short- and long-term damage due to high energy and commodity prices.•Wage-Price Spiral: The 1970s saw stronger trade unions and wage-price controls, contributing to inflation. During the Thatcher era, union power was significantly reduced. A relationship between organised strikes and union memberships is established to demonstrate the breakdown of the price-wage spiral mechanism in the UK economy. Falling union membership has led to fewer strikes and less impact on private sector wages.•Import Price Influence: Import prices can indirectly impact the consumption deflator through their connection with global fuel prices, affecting various consumer products. The import price equation features both energy and non-fuel commodity price inflation, as well as an exchange rate pass-through mechanism.•Monetary Policy: Inflation in the 2020s affects living standards through real incomes and interest rates. The model simulations confirm that the current inflation episode differs significantly from the inflation episodes in the 1970s due to reduced oil dependency, weakened labour unions, a