Shortcuts / 18 November 2021

Inflation

Inflation is a key piece of the economic puzzle, and it’s a hot topic in Oz and across the globe right now. So In this Squiz Shortcut, we’ll look at inflation and what drives it, what happens when it’s too low or too high, and how inflation is playing out now and into next year’s federal election campaign.

Alright, first things first – what’s inflation?
Very simply, inflation is what happens when prices go up. Of course, the price of goods moves up and down all the time for all sorts of reasons. There are the basics of supply and demand and then there’s hype…

So many fads…
Yep. But with inflation, it’s the measure of the movement of the average price of everything consumers buy. So inflation is different from one-off price hikes or falls – it’s something more structural.  

Gotcha…. Kind of. What actually drives it?
Inflation is linked to big events that happen here in Oz and on the world economic stage. It has to be big enough to affect the cost of what you’d buy when it comes to goods and services in a month or across a few months. So like a big weather event or the global spike in the cost of fuel and energy.

Or a global pandemic… So how is inflation measured?
It’s called the Consumer Price Index, or the CPI. How it does that by looking at a fixed basket of goods – so staples that we need to buy – and then compares how their price changes across the year. 

A basket of goods, how quaint… So how is that data then used?
It gives the people who control the policy settings a reliable guide about what’s happening with inflation and just how fast prices are going up. 

I’m guessing the CPI has a range it’s aiming for?
You’re bang on. So the Reserve Bank – the RBA which is our central bank that looks after monetary policy – wants that inflation rate to sit somewhere between 2-3% across a year. 

Why 2-3%?
The Reserve Bank has come up with this figure because at that level it reckons other parts of the economy like employment and wages growth are also functioning well. The range is necessary to look across a year so that if one month moves above or below that range, the RBA isn’t going to panic.

What would make them panic?
Well, anything that looks like it will persistently and impact Australians’ cost of living significantly and that happens if we can’t buy as much with our hard-earned as we used to. 

So if a banana used to cost $1, and now costs $4, but your salary hasn’t increased, then you might start to wonder if you really need to buy bananas…
That’s right. Or, do you keep buying it and run the risk of spending your money quicker than before? That’s what’s called high inflation.

So what’s low inflation?
Low inflation is when prices aren’t going up, or they’re going backward. That may mean people delay their spending because there’s no fear about things getting more expensive. And lower spending might lead to a stalling or fall in wages and businesses laying off staff.   

I’m starting to see how inflation has a pretty significant effect on the economy…
Exactly. If we’re not spending, businesses aren’t growing and they aren’t putting on more staff or pushing their wages up. It’s about keeping the economic wheels turning over.

I recall there’s been a lot of talk about low inflation lately…
Yep. In more recent years, inflation has been low, coming in under that 2-3% target set by the RBA. 

What does that mean for the economy?
It slows down. And when economic growth is slow it means a lot for all of us. Governments don’t get the sort of revenue they might need to build schools and roads. Businesses don’t get the opportunity to grow and offer more jobs to people. And people’s wages don’t go up, so they might not take that holiday or buy that house – so it’s all connected. 

And that’s where we’ve been for the last few years…
That’s right – inflation has basically sat under 2% since September 2014. You might remember during that time, the Coalition Government was pushing a message about getting back into surplus. 

Who could forget…
Yep – and that meant there wasn’t a lot of government money sloshing around the economy, and that has a real impact on all of us. Also, during that time, unemployment wasn’t high, but it wasn’t as low as it could be. 

Why’s that?
The labour market has changed so much – it’s international now, not just local. So with a much bigger pool to hire from – or contact work from via tech platforms – there’s been not a lot of pressure on wages to go up. 

And then the pandemic hit…
It did. What we know is that things have bounced around a lot during that time. But with people getting back out and about, there is a lot of anticipation and speculation about how our economy – and the world’s – will fare. 

So where does inflation fit into this?
Well, inflation is running hot in Europe at a 13-year high of more than 4%, In the US, it’s at 6.2% over the year to ­October – the highest it’s been in 3 decades. And here in Australia, inflation was 3% in the year to September, which is the highest it’s been for almost a decade. 

But wage growth isn’t keeping up…
Nope. So for example in the US, an inflation rate of 6.2%, and that’s been accompanied by a 5% rise in workers’ salaries. 

And in Oz?
Our 3% inflation compares to wages growth of less than 2% this year. These things are dynamic, the numbers are moving all the time, but that’s the scoreboard. 

So why is inflation high right now?
There are 2 main factors. The first is the energy crisis in Europe and Asia – and there are some specific reasons for that relating to measures to meet emissions reductions commitments, a surge in demand for power as businesses fire up again as they move on from COVID, and the politics around oil and gas pipelines. We’ve already seen some consequences here with petrol prices surging to record highs – that’s all part of it. 

I can’t even look at the price of petrol right now… What’s the second thing?
Supply chain blockages. So because of the pandemic, it’s harder to get stuff. And there’s been a recent spike in demand for goods but there’s still a shortage of workers as we shake off COVID.

So despite all of this, inflation is on the RBA’s radar, but it isn’t enough of a concern to panic?
That’s right, and I’ll defer to the guy in charge of the RBA on that. His name is Dr Philip Lowe and he’s the man who can pull levers on this. What he says is that many of the factors that have caused inflation and wages to rise sharply elsewhere are “more muted” in Australia. 

Why’s that?
Well, Governor Lowe reckons that the jump in inflation that we’ve seen recently is a lot about a surge in demand coming out of COVID lockdowns. He also says that “prices aren’t likely to keep rising at current rates as conditions normalise, and some prices may even decline”.

What does that mean?
It basically means that as we exit the phase of the pandemic that has seen lockdowns, closed borders, and restricted travel, the RBA expects things to start opening up again and become a bit more normal. 

So is that a prediction or can the RBA influence inflation?
Well, one of the RBA’s jobs is actually dealing with inflation. One of the biggest levers it has is interest rates. 

And how are interest rates tied up with inflation?
Well, if interest rates go up, the idea is that it has a cooling effect on the economy. People spend less, and things slow down. But for now, Governor Lowe says interest rates are set to stay at that record low level of 0.1% for some time to come, potentially until 2024. 

We’re also in an election year…
Yep. And it’s likely inflation will be something that will be coming up quite a bit. Just this week an economist was talking about how huge the issue of managing costs of living pressures has been in the last few election campaigns. That was when there was very low inflation, so just imagine what it will be like during a period when inflation is potentially a thing. 

And we’ve already had a taste of what’s to come this week…
We have… PM Scott Morrison has been out and about talking to voters since coming back from those international summits, and he has hit that inflation note. He says that under Labor, “you’re going to see petrol prices go up. You’re going to see electricity prices go up. You’re going to see interest rates go up more than they would need to.” 

What’s that about?
That goes to the debate that Coalition governments run tighter budgets than Labor, and at this tricky economic time coming out of COVID, Morrison believes his government will do a better job keeping those things in check. 

I’ve heard those lines from Coalition leaders before…  What does Labor say?
They have called that sort of thing a “tired and laughable old scare campaign” and that last time they looked Morrison didn’t control world oil prices or supply chains. They say they will run a responsible budget, and there’s no evidence in their policies that prices and interest rates will go up. 

Bring on the election…
Yep, it’s something you’ll be hearing a lot about from us in the coming months. We’ll bring the popcorn…

Squiz recommends:

Zimbabwe’s inflation and currency problems explained – BBC Africa

RBA website

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