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Title of the article UK real wages decline at record rate as inflation soars
Source of the article
Date the article was published 16/08/2022
Date the commentary was written 22/08/2022
Word count 761
Key economic concept Economic well-being
Section of the syllabus Macroeconomics

In the second quarter of 2022, the real wage level in Britain fell at the fastest rate in at least 20 years. However, the labor market is still too tight, making the Bank of England uneasy about the inflationary pressure. The decline of workers' real wages and the rapid rise of inflation rate have led to a sharp rise in the cost of living while the purchasing power has been continuously reduced, which will have a negative impact on Economic well-being. Economic well-being refers to the satisfaction of people's various desires or needs and the happiness and happiness they feel. Personal welfare is an important part of Economic well-being, and personal income is an important determinant of Economic well-being. The higher the actual wage level, the more welfare people get. The inflation rate in Britain has risen sharply, but people's real wages have decreased, which has lowered the level of Economic well-being, which is mainly manifested in that people need to buy fewer goods at higher prices.
In a balanced economic state, the total demand AD and the total supply as of the United Kingdom intersect at point E, and people use the price  to buy commodities in  quantity. Affected by the COVID-19 epidemic, the inflation rate in the UK has increased, and the price of goods has exceeded the wage growth rate, resulting in a decrease in real wages, thus reducing people's daily expenses, reducing consumer demand, and the AD curve moves downward to the left to . At the same time, the lower the real wage, the less labor force is supplied. The contraction of the labor market leads to the reduction of the total supply, and the AS curve moves upward to . At the new equilibrium point , the price level is , which is higher than the original equilibrium price , but the new output quantity is , which is lower than . This means that consumers spend more money to buy fewer goods, and people's economic well-being level drops.
Figure 1. AD-AS model after real wage decrease
In order to reduce the negative impact of rapid inflation rate on economic well-being, “the Bank of England responded to rising prices earlier this month by raising interest rates by 50 basis points to 1.75% - the largest single increase in 27 years”. The measures taken by the Bank of England to reduce interest rates are a kind of tight monetary policy, which is shown as the downward left movement of the AD curve in the AD-AS model, because the increase in interest rates reduces the total demand. The tight monetary policy makes the aggregate demand curve move  to the left  and has no effect on the aggregate supply curve .  and  intersect at . At this time, the determined equilibrium price is , lower than , and the output level drops to . It can be seen that although the increase of interest rate further reduces the output level, it suppresses the inflation rate and lowers the price level of residents' consumption.
Figure 2. AD-AS model after interest rate increase
Finally, the evaluation of whether the Bank of England's interest rate increase will improve economic well-being showed that the central bank's increase in the bank's deposit and loan interest rates will allow more people to deposit money in the bank, obtain income, increase storage, reduce consumption, and directly reduce the currency in circulation in the market, thus indirectly easing inflation. This has a certain effect on improving economic well-being. However, the increase of interest rate may have a negative impact on stakeholders. The cost of social production and operation has increased, which may affect industrial and commercial operations and ultimately affect employment. Production and operation definitely need loans to borrow money. The increase in interest will lead to the increase in the operating costs of enterprises. Many enterprises are forced to give up their normal operations, social investment will be reduced, and the economy will slow down. The number of new employment opportunities will be less. Enterprises may even lay off workers, and the number of unemployed people will increase, which is not conducive to the improvement of economic well-being. Therefore, the government should take inflation and unemployment into account when conducting regulation and control, and carry out appropriate regulation and control from the overall level.