There appears to be a blissful collective hallucination among my learned fellow Crikey columnists surrounding the cause and solutions to Australia’s inflation problem.
That is, repeated claims that Russia’s invasion of Ukraine and supply chain challenges have caused recent price rises (inflation clocked in at a 35-year high of 7.8% in January). And hence that the RBA increasing interest rates is foolhardy because it won’t reduce inflation anyway and will harm Australian workers.
This is magnificently wrong on every count.
Supply-driven inflation can absolutely be a thing. Take the 1973 oil crisis, which saw the oil price increase from US$3 to US$38 a barrel. In most cases, cost-push inflation is rarely a long-standing problem. In time consumers find substitutes, and in the medium term they change behaviours (higher oil prices led to consumers switching SUVs for smaller, more efficient cars, for example).
Most inflation is demand-driven: too many dollars chasing too few goods (and caused by excessive debt). This is the case now, and blaming COVID or supply chain issues is to be blissfully ignorant of the actual data.
Let’s look at oil, arguably the commodity that most impacts inflation (especially at a consumer level). Oil is well below its peak (below is a graph tracking the inflation-adjusted crude oil price). Other than a few brief moments in 2015 and 2017, you need to go back to 2005, prior to the 2007-08 global financial crisis, to see sustained lower prices:
It isn’t just oil that has reverted to the mean. Lumber costs, a key ingredient in building, have fallen by almost 80% to trend at pre-COVID levels:
The Baltic Dry Index, which tracks the costs of international shipping and is a key indicator of trade demand, is down 77% and back below pre-COVID levels:
The notion that inflation is supply-driven is simply not justified by the data. For example, the main reason building remains so expensive is the difficulty in sourcing labour. (This will adjust in time, when residential and commercial building starts falling and skilled immigration returns.)
While the Reserve Bank got it wrong for almost a decade when it kept interest rates far too low, RBA governor Philip Lowe is getting it half right in raising interest rates (although rates should be far higher than the historically low 3.6% they remain).
Moreover, the notion that higher interest rates are somehow an attack on the lower class or working poor is nonsensical.
Higher rates impact leveraged asset owners, especially those with multiple investment properties or leveraged operating businesses. As the cost of debt increases, the value of these assets usually declines (witness the recent falls in residential housing and share prices).
Similarly, the past two decades of irrationally low interest rates (in most cases, below the level of prevailing inflation), have led to an unprecedented run-up in almost every asset class, from residential property to cryptocurrencies to art and other luxury goods (for a brief period, Bernard Arnault, CEO of luxury good supplier LVMH, was recently the world’s richest person).
For those who don’t own assets, like younger people who cannot afford to buy a property, rising interest rates are a triple benefit. First, it reduces the net cost of assets like housing (and means less debt is needed in the first place). Second, higher interest rates reward savers (like those trying to accumulate a deposit). Third, higher rates lead to lower demand-pull inflation levels, which means real wage growth (that is gross wage growth, less inflation) improves (or more accurately, less bad).
The bizarre argument that has circulated in Crikey and proffered by Greens Senator Nick McKim (who himself owns multiple investment properties), that higher interest rates harm the young and the poor, is self-serving tripe. One suspects if you created a Venn diagram considering wealthy property owners and those demanding Philip Lowe be sacked for daring to increase rates, there would be a very significant overlap.
Interest rates naturally should remain 2-3% above the prevailing underlying inflation rate (they remain almost 4% below it), anything else penalises savers and rewards asset-owning speculators. Rest assured, even with 10 consecutive rate rises, policy settings remain highly expansionary.
Have economy-watchers got the wrong idea on inflation and rate rises? Let us know your thoughts by writing to letters@crikey.com.au. Please include your full name to be considered for publication. We reserve the right to edit for length and clarity.
