Understanding the Effectiveness of Incomes Policy in a Two-Household SFC Model of the UK

This paper explores counterfactual scenarios using a two-household stock-flow consistent (SFC) model of the UK economy. Following the COVID-19 pandemic, the UK experienced a sharp surge in inflation, to which the Bank of England responded with monetary tightening measures starting 2023. Scholars have argued that this response was relatively late, limiting its effectiveness. Our analysis shows that post-COVID inflation was primarily driven by import price shocks, further constraining the impact of monetary policy. Counterfactual scenarios indicate that even earlier implementation of monetary tightening would have yielded limited reductions in inflation and could have worsened income distribution. In contrast, scenarios incorporating effective income policies reveal that if such measures had been introduced earlier by 2022, inflation could have been reduced by over 2 percentage points, while significantly improving income distribution. These findings highlight the critical role that targeted income policies could play, alongside conventional monetary interventions, in addressing post-pandemic inflation.