Inflation in the United States just hit 5.4%. Guys, that’s a lot. As this graph shows, the US inflation rate is the highest it has been in 11 years.
Does 5.4% inflation sound high? It is. It means you would need to earn 5.4% interest on any money you have in the bank just to break even. Because as prices rise, the spending power of money falls. If a 5.4% rate of inflation was maintained, prices would double every 15 years. (e.g. a $5 box of cornflakes would cost $10 by 2036).
Inflation is generally seen as bad news for savers. Your nest egg can buy only half as much stuff if inflation doubles prices. And after all, buying stuff is what nest eggs are for. For people with debt — and that’s lots of us — inflation can be helpful, as it eventually makes the debt seem smaller. But it’s important to take into account interest rates.
The rate conundrum
The most important effect of high inflation for Aussies might be that it causes higher interest rates. The Reserve Bank of Australia (RBA) uses interest rates to control inflation. (Inflation is like the heat given off by the economic engine, and low interest rates are an accelerator. If the engine gets too hot, the RBA takes its foot off the pedal by raising rates.)
For Aussies with a stake in our $1.9 trillion in mortgage debt, the big effect of higher interest rates would be higher mortgage repayments.
Is Australia at risk?
There are two big things you’ll hear about this rise in inflation.
The first is: don’t worry, it’s just a blip. It only looks high because last year inflation was low — annual inflation is measured by comparing this year with the same time last year. And yes, it’s true, this time last year US inflation was around zero.
The second thing you’ll hear is this: time to panic, this is the return of sky-high inflation.
That may be an exaggeration. But there’s a grain of truth in it, too.
The policies that governments around the world have engaged in — low, low interest rates and high, high spending — are the exact ones that have historically caused inflation. Of course, they also cushioned the economy from the effects of the pandemic. The reason Australia has unemployment at the same level as it was pre-pandemic (and underemployment lower than it was pre-pandemic) is because these policies did a lot of good work.
So, will those useful policies unleash a wave of inflation that will torment us over the next few years? It’s worth remembering that inflation in Australia used to be more than 15% (and interest rates were even higher). We haven’t seen high inflation for a long time, but it’s not completely out of the question. Supply shortages and shipping congestion are pushing up prices for a lot of imported goods.
A massive policy question for the nation to confront is whether the RBA should let inflation run a bit hot, or whether it should step in. In the past, the RBA has always focused on keeping inflation down — that’s why the red line in the graph above has been falling for the last 20 years. But recently it has been more focused on the labour market and worrying about unemployment. If it stamps out inflation, it also tends to stamp out jobs growth and wages growth.
This time, the RBA has suggested, it will let inflation get a little bit higher than usual before it acts. It will put up with inflation numbers of 3% for a while, if it helps get unemployment down to about 4% and wages growth up to about 3%.
Is inflation worth enduring if it gives us better employment outcomes? It’s a tough trade off. What must also be remembered is how rapidly Australian politics can pivot to being about cost of living, at the exclusion of just about everything else.
If we ever notch up an inflation result like the US’s 5.4%, expect the political discourse to focus in on it like a dog on a bone. Albo and ScoMo would talk cost-of-living non-stop. And that’s bad news for anyone who’d like politics to aim a bit higher.
What do you think? Should the RBA leave inflation high for a while, or work at getting it down now? Send your thoughts to letters@crikey.com.au, and don’t forget to include your full name if you’d like to be considered for publication.
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