Australia’s cost of living crisis is hitting ordinary households, and it’s not over anytime soon | Satyajit Das
Jhe cost of living crisis is undermining the preferred election year narrative of a strong post-pandemic recovery. Politicians, regardless of their ideology, now find themselves trapped by fast-moving events, mostly beyond their control.
First, despite messages from the central bank about transitory, low and gradual inflation, Australian consumer prices are rising at 3.5% per year and the increases are expected to accelerate.
But the true figure is probably higher. One estimate puts actual US inflation at around double the official 7.9%. The Reserve Bank of Australia’s preferred trimmed average inflation figure ignores 15% of the highest and lowest price increases. In the 1980s, a Latin American finance minister defended the exclusion of items that had risen sharply in price on the grounds that no one could afford them.
Second, current inflationary pressures reflect an unusual combination of demand and supply factors, many of which are likely to persist.
Demand was supported by pent-up post-lockdown spending, low interest rates and central bank liquidity. Funded by central bank bond purchases, government spending (sometimes poorly targeted) has far outpaced revenue declines during the lockdowns.
Simultaneously, short- and long-term supply problems, now exacerbated by the conflict in Ukraine, have created shortages of basic commodities, goods and services. Oil prices have quintupled since artificial lows in 2020 due to energy policy and a poorly planned and executed energy transition to renewables. Rising food prices reflect extreme weather conditions, particularly droughts and floods.
Supply chains have yet to fully recover from isolation requirements, mobility restrictions and border closures that have disrupted production and transport links. As long as China’s zero Covid-19 policy continues, periodic shutdowns of factories and ports are possible. Geopolitical tensions between the West and China and now Russia and associated trade restrictions and sanctions have affected trade, technology transfers and investment flows.
All of these factors lead to higher prices, delays and increasingly unreliable availability.
Third, policymakers lack the tools to bring inflation under control, at least quickly. Standard operating procedure is to drop demand to match production. But cutting government spending, raising rates and reversing accommodative monetary policies could jeopardize a fragile recovery in an economy dependent on stimulus and facing other ups and downs.
Actions, such as a one-off payment to the most affected or the reduction of fuel taxes, will have a limited and short-term impact. If they are not offset by adjustments elsewhere, they will increase – not reduce – demand, adding to price pressures and potentially damaging public finances.
Rising interest rates are problematic. With high inflation, to be effective, central banks would have to rise sharply – by at least 4-5% – to normalize real interest rates. In the “everything bubble”, such increases could lead to lower house and stock prices, well beyond the relatively modest corrections experienced since the end of 2021. It would also increase interest charges on the high level of public, corporate and household debt, in particular mortgage loans.
The financial distress of overburdened borrowers is likely to cause a new financial crisis. This means that any rate increases will need to be carefully calibrated to avoid side effects, limiting their effectiveness.
Supply-side policy options are limited. Financial finagling cannot control the pandemic, eliminate extreme weather, increase production of goods and services, or bridge geopolitical divides. Governments can help develop critical infrastructure and fill labor gaps, but it will take years.
The only other option – mandatory government price controls – has proven ineffective in the past. Where the market price is artificially capped, hoarding increases, black markets arise, and resources are diverted to seek better returns elsewhere.
Finally, while paying attention to price stability, the government and central banks may have a greater tolerance for inflation for several reasons.
The authorities have spent almost 15 years trying to raise inflation to avoid deflation that could harm a debt-ridden economy. Higher prices stimulate economic activity by encouraging consumption as buyers step up their purchases for fear of rising costs. Inflation is also useful in coping with high levels of borrowing. It increases tax and trade revenue to help meet debt repayment. It also reduces purchasing power, lowering real debt levels. It allows for a stealth decline in living standards and devalues the currency, thereby increasing Australia’s international competitiveness.
With wages unlikely to keep pace with this price rise (Bank of England Governor Andrew Bailey controversially told Britons not to ask for a raise this year despite the threat of inflation galloping), the cost of living crisis is unlikely to ease soon, affecting ordinary households. and the exacerbation of inequalities, regardless of the designated electorate.
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