Economic growth is the worst

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A quick summary

  • Economists push the need for more and more economic growth

  • But economic growth has very serious negative consequences

  • But also: economic growth is super important. It boosts people’s living standards and creates the resources to fund a range of economic initiatives

  • The challenge is how to grow in a way that mitigates some of the negative impacts

Don’t be fooled

“Economic growth is terrific.”

You hear this from your teacher or an economist or maybe even a politician.

But I implore you: be skeptical of this claim. Economic growth is terrible*. 

I’ve got four reasons why economic growth sucks. Or, in a more articulate way, there are four negative consequences of economic growth.

(*Please read all the way to the end.)

Economic growth is terrible because it results in higher prices

Let’s say economic growth is rising in an economy. So aggregate demand is rising…however, firms may not have enough time to increase production to match this rise in demand. 

Look at it from this perspective. As the economy grows, consumers’ incomes rise. This means they can afford more goods and services. However, there is limited stock of goods and services. 

“In fact, consumers use their extra income to ‘bid up’ the prices of limited goods and services, which then results in higher prices. I like to think about extra money ‘chasing’ the same amount of goods and services.”
— Mr Symonds

So we would say that the rise in aggregate demand is outstripping aggregate supply (because firms haven’t had time to produce more goods and services). This leads to demand-pull inflation.

[Just remember: aggregate demand affects economic growth in the short term, while aggregate supply affects growth in the longer term.]

But we may also see cost-push inflation. This is because higher economic growth leads to greater demand for the inputs of production, which will lead to higher costs for businesses. 

Think about it this way: economic growth leads to greater demand for labour, which will result in lower unemployment. As firms need more and more workers, they will need to pay higher wages to poach them from other firms (because unemployment is so low). This leads to higher inputs costs (wages) which will result in firms pushing up the prices of goods and services (cost-push inflation).

Also, during a period of economic growth, many firms will demand more inputs to meet the higher demand for goods and services. As a result, the prices of inputs like raw materials will also rise and this will further lead to cost-push inflation.

Learn more about cost-push inflation

Economic growth is terrible because it results in higher prices and then higher interest rates

As we’ve seen in the previous section, higher economic growth generally leads to rising inflation.

If inflation is rising in Australia, the central bank will act. The Reserve Bank will raise the cash rate, the official level of interest rates, to indirectly increase interest rates across the economy and slow inflation.

What’s the issue with the higher rates?

The RBA will act.

Australia’s central bank will adjust the cash rate if inflationary pressures are rising.

Image: RBA

Higher interest rates will result in less investment. This is because higher rates mean higher interest repayments for borrowers. 

Higher interest rates could also result in a higher exchange rate. This is because more foreign investors could be motivated to save their money in Australia as the returns could be higher. A higher exchange rate could make Australian exports less competitive. 

Economic growth is terrible because it results in environmental degradation (and therefore lower living standards)

Economic growth is still highly dependent on the use of fossil fuels. In order to increase output, we need to use non-renewable resources, such as oil and minerals, which reduces the ability of future generations to harness these resources.

The more economic growth, the more pollution.

In addition, the use of fossil fuels leads to higher pollution. This leads to environmental degradation (which may not be fixable) and potentially lower living standards. Think about how pollution could result in poorer air or water quality. This has negative implications for future generations.

Economic growth is terrible because it can worsen income and wealth inequality

This is a trickier point. One view is that economic growth will reduce income inequality as it results in higher wages for lower-income earners. Or that it leads to the unemployed gaining jobs which then leads to them having higher wages. And overall, income inequality is reduced.

There’s another view to consider.

The wealthier people in society own more assets, including shares, homes and investment properties. So if the economy grows and asset values rise, this would deliver greater benefits to those who are already wealthy. They would receive greater dividends, rent and other incomes flows from their assets. According to this view, as economic growth rises, income and wealth inequality could rise.

*But we need economic growth

Yes, economic growth has negative consequences. Quite serious negative consequences in some cases. But we need economic growth.

This blog post has a deliberately sarcastic tone. Don’t start writing essays where you make the case for GDP growth of 0%. This will be unhelpful for your marks.

You see, economic growth delivers so many benefits to a country and its population, including rising living standards and higher wages.

The issue here is how we pursue economic and growth and what do we do with the benefits of economic growth.

For example, could countries try to grow more sustainably, with less of a reliance on fossil fuels? And could countries direct some of their benefits from economic growth to addressing some of the negative consequences of growth? 

We can’t choose not to grow. But we can talk about how economies should choose how they grow.

Australia's inflation rate is rising rapidly

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Quick summary:

  • Australia’s inflation rate is rising rapidly — in the March quarter 2022, consumer prices are rising by 5.1 per cent in annual terms

  • Prices are rising across most sectors of the Australian economy, particularly for food, housing and transport

  • The Reserve Bank of Australia will being raising the cash rate to slow inflation and bring it back into the central bank’s inflation target band of 2 to 3 per cent over the course of the business cycle.

The Reserve Bank of Australia (RBA) has a target for Australia’s inflation rate of between 2 and 3 per cent. In the March quarter of 2022, Australia’s yearly inflation rate was 5.1 per cent. 

“Australia, we have an inflation problem.”
— Mr Symonds, April 2022

What is inflation?

Inflation is a sustained increase in the general level of prices. The important point is “sustained”. We’re not looking for a one-off jump in prices. As economists, we’re looking for price rises that persist for a period of time.

The “sustained” part is crucial because we don’t want to change economic policy for temporary things. For example, if prices rise in one quarter, but fall the next, the RBA may not need to raise the cash rate. But if we see prices rise quarter after quarter, it may be time for a tightening of monetary policy (higher cash rates).

Are you wondering what inflation even is?

Check out my video.

How is inflation measured?

Every quarter the Australian Bureau of Statistics (ABS) publishes the Consumer Price Index (CPI). This measures the changes in prices for the types of goods and services that households spend most of their money on. 

The ABS refers to this as a ‘basket of goods’. These goods and services are weighted based on their relative importance to households. This is because a rise in the price of certain goods and services would have more of an impact than others. For example, a rise in the price of food would be weighted more heavily (have more impact on the CPI) than a rise in the price of Prada sneakers. 

Why? Because the sad truth is more households can afford food than Prada sneakers.

“The sad truth is more households can afford food than Prada sneakers.”
— Mr Symonds, April 2022

The ABS’ ‘basket’ covers eleven groups:

  • Food and non-alcoholic beverages

  • Alcohol and tobacco

  • Clothing and footwear

  • Housing

  • Furnishings, household equipment and services

  • Health

  • Transport

  • Communication

  • Recreation and culture

  • Education

  • Insurance and financial services

What happened to Australia’s inflation rate in the March quarter of 2022?

In late April, the ABS published the March quarter CPI. This covers January, February and March 2022. 

Australia’s CPI rose by 2.1 per cent in the March quarter compared to the December quarter. By way of comparison, the CPI rose by 1.3 per cent in the December quarter of 2021 compared to the September quarter of 2021.

So: inflation is clearly on the way up.

Moreover, the annual rate of inflation has increased substantially. If we compare the March quarter of 2022 with the March quarter of 2021, the CPI has risen by 5.1 per cent.

Your quick summary of Australia’s complex inflation picture. You’re welcome.

Which prices are rising fastest in the Australian economy?

You can see the main contributors to the rising inflation rate in the graph below. 

Let’s focus on a couple of the areas.

Food and non-alcoholic beverages (up by 2.8 per cent in the March quarter)

  • According to the ABS, prices across ALL food and non-food grocery products in the March quarter

  • This was due to the cost of COVID-related supply chain disruptions (reducing stock and pushing up prices), rising transport costs (related to the rising cost of fuel) and challenging weather conditions such as floods


Housing (up by 2.7 per cent in the March quarter)

  • Australia’s housing market was relatively strong in the quarter which led to higher prices for homes and rents

  • In addition, there are rising construction costs for new home builds and renovations. Builders are passing on these costs to home owners, resulting in rising prices


Transport (up by 4.2 per cent in the March quarter)

  • The price of petrol rose by 11 per cent due to the a spike in global oil prices following Russia’s invasion of Ukraine

  • Petrol prices have also risen as COVID-related travel restrictions have eased and people are demanding more fuel as they travel greater distances

  • Car prices have also been rising as supply chain disruptions have restricted the arrival of new cars into Australia (less supply combined with strong demand leads to higher prices)

Just look at this chart of how fast petrol prices have risen in the Australian economy. Businesses are passing these costs on to consumers; this then results in cost-push inflation.

Petrol prices are really pushing p…rices higher.

Headline versus underlying inflation

Australia’s headline inflation rate includes all prices changes in the economy. Australia’s underlying inflation rate excludes one-off or volatile price changes in the economy.

The RBA focuses on underlying inflation. This is because when the central is deciding whether or not to change the cash rate, it wants to respond to ongoing trends in the Australian economy and NOT one-off price shocks that might quickly dissipate.

The RBA looks at two measures of underlying inflation — the trimmed median and weighted mean. Don’t worry too much about what they’re called. Just know this: the RBA’s preferred measures of inflation show that Australia’s underlying inflation rate in the March quarter 2022 is around 3.45 per cent — above the central bank’s target band of 2 to 3 per cent.

Read more about the RBA’s measures of inflation.

What are the impacts of Australia’s rising inflation rate?

The key impact is that the cash rate will soon rise. This could happen as early as 2 May when the RBA holds its next board meeting to discuss the cash rate.

This means Australia’s monetary policy will have a contractionary stance and wil slow the level of economic growth.

At the same time, Australia’s fiscal policy — the federal budget — is still having a large expansionary impact on the Australian economy. Read about it here.

Your favourite businesses are raising prices. Here's why

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The quick version:

  • Cost-push inflation is when rising input costs lead businesses to raise retail prices

  • Rising input prices include higher wages, energy and rent costs (these higher costs push up retail prices)

  • Cost-push inflation is happening in Australia in 2022. According to the National Australia Bank, business purchase costs are at record levels. This is leading to higher inflation in the Australian economy.

Cost-push inflation is rising in Australia.

 

What is cost-push inflation?

Cost-push inflation is a cause of inflation. It occurs when higher input costs for businesses PUSH UP prices across the economy.

Basically firms face higher input costs and, rather than absorb these costs and reduce profits, they pass on higher costs to consumers. 

The end result: consumers pay higher prices.

An example of cost-push inflation

As of April 2022, Australia’s unemployment rate is a very low 4 per cent. This means that businesses may find it hard to secure workers as many people are already employed. To attract workers, firms may need to pay higher wages. And wages are a cost for businesses.

A firm could absorb the higher wages cost. But this would reduce their profit (as profit = revenue - costs). Instead, the firm will pass on the cost of higher wages to consumers in the form of higher prices. Consumers will ultimately pay for the higher employee wages. 

When prices rise, inflation rises. In our example, input costs (wages) have pushed inflation higher.

Other sources of cost-push inflation could be higher energy prices (electricity or petrol), more expensive food and higher rental costs.

How cost-push inflation works

Cost-push inflation in the Australian economy in 2022

National Australia Bank (NAB), one of Australia’s big four banks, publishes a monthly business survey. According to the survey, firms’ purchase costs (the cost of their inputs) rose by 4.2 per cent in the March quarter.

[The March quarter covers January, February and March.]

This 4.2 per cent rise is a record for the NAB survey. The survey also found that labour costs — as discussed in our example above — rose by 2.7 per cent in the March quarter. This was another record rise.

NAB Chief Economist Alan Oster said that many industries were experiencing rising input costs. This is what the survey calls ‘purchase costs’.

“Purchase costs reached records with elevated oil prices adding to existing supply chain issues, and labour costs are also rising as businesses hire more workers in a very competitive labour market,” Mr Oster said.

These rising input costs are leading directly to higher prices. According to the NAB survey, retail prices rose by 3.7 per cent over the March quarter of 2022. This is a record level for the survey.

Why does cost-push inflation matter?

Rising cost-push inflation is another sign that Australia’s inflation rate is rising (potentially rapidly) . This adds to the likelihood that the Reserve Bank of Australia will soon begin raising the cash rate to try and control inflation. The RBA meets monthly and many economists believe the cash rate could be raised as soon as June 2022.

When we talk about the RBA raising rates, we’re discussing monetary policy. Check out this article for more about this important macroeconomic policy.

The Five Sector Model (Circular Flow of Income) and economic growth

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The Five Sector Model* is a simplified model of how an economy works. It shows how money moves around an economy and involves five sectors only: households, firms, the financial sector, the government sector and the international sector. 

[*The Five Sector Model is also known as the Circular Flow of Income Model. Same same.]

If you’re new to the concept, I’ve got a video (below) and you can read more about it here.

In terms of the Five Sector Model, we have injections (money flowing into the economy) and leakages (where money leaves the economy). 

The injections are Investment (I), Government Spending (G) and Exports (X). The leakages are Savings (S), Tax (T) and Imports (M). 

Let’s look at the relationship between injections and leakages.

When the value of injections EQUALS the value of leakages, the economy is in a state of equilibrium. The economy is neither growing nor slowing; it’s stable.

When the value of injections EXCEEDS the value of leakages, the economy is growing. More money is flowing into the economy than is leaving. As a result, gross domestic product (GDP) is likely rising, unemployment is likely falling and prices are probably on their way up (higher inflation).

When the value of leakages EXCEEDS the value of injections, the economy is slowing. More money is being removed (or withdrawn) from the economy than is being pumped into it. As a result, GDP is likely falling, unemployment is on the rise and prices and probably dropping (lower inflation).

Let’s take an example question. This is Q14 from the 2017 NSW HSC Eco exam.

Source: NESA

Source: NESA

If we do the quick maths, we can see that injections equals 115 and leakages equals 125. So this would indicate the the economy is contracting — our answer would be D.

We can also use the Five Sector Model to talk about the budget balance and the trade balance, but we’ll leave this for another post. (For a headstart, check out Q9 from the 2019 HSC Eco exam.)

Inflation is really low in Australia. Why?

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Reserve Bank of Australia (RBA) Governor Philip Lowe did a great thing for Eco students everywhere. He very clearly answered this question: Why is inflation so low in Australia? 

I suggest you read the speech and his full text. But I’ll also give you the gist.

(Gist: the substance or general meaning of a speech or text.)

Essentially Governor Lowe cites three reasons for Australia’s low inflation rate (as of July/August 2019). These points are also in the video on the right.

First, Dr Lowe talks about the effectiveness of credibility of monetary frameworks. This is a delicious piece of jargon if I ever encountered one. When we talk about monetary frameworks, what we mean is the inflation targeting part of monetary policy. So, in Australia, the monetary framework involves the RBA’s efforts to keep inflation to between 2 to 3 per cent over the course of the business cycle. 

Importantly, the RBA’s monetary framework is CREDIBLE. This means that people believe the RBA will act to keep inflation in the target band. In this way, people expect low inflation so they will act in a way that causes low inflation. Or, in another sense, they DO NOT expect high inflation, so they won’t yell for higher wages or cause price-wages spirals. Most of the time.

Second, Dr Lowe talks about the presence of spare capacity in the Australian and global labour markets. This means that there is unused or underutilised labour in the Australian economy. So, if firms do need more workers, they can hire from the existing pool — they do not need to bid up wages to attract workers. This keeps wages down and keeps a lid on inflation.

On this point, Governor Lowe talks about how aggregate demand is not growing fast enough to require more workers and reduce the underutilisation rate (the unemployment rate plus the underemployment rate). Faster domestic growth would be helpful to improve the labour market.

Third, Dr Lowe talks about how globalisation and improvements in technology have reduced prices around the world. In Australia, online shopping has increased competition and pushed retail prices down. Better technology means companies can produce more efficiently and reduce prices for consumers. All these factors will result in lower inflationary pressures.

But this doesn’t mean the RBA’s given up on trying to boost inflation back into the target band. Dr Lowe and the RBA have been very clear that interest rates will remain at low levels for some time to try and stimulate the economy (see quote below). 

From the RBA’s August statement after keeping the cash rate on hold. Interest rates low for some time yet.

From the RBA’s August statement after keeping the cash rate on hold. Interest rates low for some time yet.