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.

Tough times for the Australian economy, says RBA

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Four times a year, the Reserve Bank of Australia (RBA) shares its assessment of current economic conditions for Australia and the world. This document is called the Statement of Monetary Policy (SOMP). The SOMP for May 2020 sets out some serious challenges for the Australian economy.

I think, as a student, the most important section to focus on is Section 6: Economic Outlook. 

I discussed this section in a previous post that looked at the RBA’s three potential scenarios involving the Australian economy’s recovery from COVID-19.

In this post, I’ll take a look at some specific economic forecasts from its May SOMP.

Economic growth

According to the RBA, the Australian economy is “expected to record a contraction in GDP of around 10 per cent over the first half of 2020”. Considering Australia’s GDP grew by around 4 per cent in the first half of 2019, this is a huge turnaround — in a negative sense.

Why is GDP expected to plummet? Well, social distancing means people aren’t going to the shops and spending. The RBA forecasts household spending to fall by 15 per cent in the June quarter this year. In addition, consumers are saving more, as people tend to do in times of uncertainty. 

Australia is also not receiving international visitors and their tourist spending. This is classified as export revenue for Australia, and a component of aggregate demand (AD). Less exports mean less economic growth for Australia.

On the flip side, Australians are expected to spend much less on imports. 

 

Unemployment

The RBA estimates that total hours worked in the Australian economy will fall by around 20 per cent in the June quarter (the three months to June 2020). In addition, the RBA says unemployment could rise to around 10 per cent by the same point in time. 

Considering the unemployment rate was 5.2 per cent in March 2020, this could represent a near doubling of the number of Australians out of work.

But here’s the thing: while the unemployment rate may not increase by this much, we should still be concerned.

This is because of what’s called “the discouraged worker effect”. This is when an individual gives up looking for work because they don’t believe they will be able to get a job. If people give up looking for work, they’re not considered unemployed and they’d join the hidden unemployed. 

(In Australia, to be considered unemployed, you must be out of work and actively seeking a job.)

So Australia’s unemployment rate may not increase by the expected amount, but the economy would still have lost substantial labour resources.

Inflation

Australia, for some time pre-COVID-19, has recorded relatively low inflation rates. This has been part of the reason why the RBA had steadily cut official interest rates. 

Due to the pandemic, the RBA expects inflation to turn negative in the June quarter. So: Australia would record deflation. 

Why would this happen? Two main reasons. One, fuel prices have fallen dramatically. Just have a look at this chart of unleaded petrol prices in Sydney and how they’ve fallen this year.

Source: PetrolSpy

Source: PetrolSpy

Two, the Federal Government is providing free childcare to families. So the price of childcare has fallen from something to, well, nothing. These two factors will drag down headline inflation.

Three roads to recovery: The RBA's scenarios for the Australian economy (COVID-19)

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Four times a year, the Reserve Bank of Australia shares its assessment of current economic conditions for Australia and the world. This document is called the Statement of Monetary Policy (SOMP). The SOMP for May 2020 sets out some serious challenges for the Australian economy.

I think, as a student, the most important section to focus on is Section 6: Economic Outlook. This is the section that I’ll be discussing in this post. 

Three scenarios for recovery

An important part of May’s SOMP is that the RBA has set out three scenarios for Australia’s recovery from COVID-19. 

Let’s start with the RBA’s “baseline scenario”. I think we can characterise this as the forecast where things steadily improve. Here are some elements of this scenario:

  • Australia’s social and business restrictions continue to be relaxed and are mostly removed by the end of September 2020

  • The spread of COVID-19 in Australia remains limited

  • GDP growth turns around in the September quarter and the Australian economy steadily improves.

Next, is the RBA’s more optimistic scenario. Here, Australia is more successful in containing the virus’s spread; restrictions are eased much more quickly (well before September); and business and household confidence is not as damaged and can therefore recover more quickly. 

Finally, we have the RBA’s more pessimistic scenario. Here, the outbreak persists or flares up again, which would prolong restrictions and delay the reintroduction of activities such as international travel. This situation would result in greater damage to business and consumer confidence, with more jobs being lost and businesses failing. 

There are big differences in outcomes between the three scenarios. Have a look at the graph below.

A couple of things to note. The value of GDP in December 2019 is given an index value of 100. So, if GDP falls below the December 2019 level, the index will dip below 100; if GDP rises above the December 2019 level, the index will be above 100. 

Under the RBA’s baseline situation (pink), Australia’s GDP will grow beyond its December 2019 levels in around late 2021. In the optimistic situation (yellow), Australia’s GDP could turn positive by early 2021. And in the pessimistic scenario (the sad brown colour), Australia’s GDP will still be below the December 2019 levels going into 2022.

You can see the same thinking for unemployment in the graph below. Just look at the difference between optimistic and pessimistic situations. (With unemployment, the measure is the unemployment rate, so a lower number is better).

So what actually happens? Which scenario really takes place? We’ll have to wait and see. 

So. You've decided to teach Monetary Policy...

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Teaching Monetary Policy?

This is tough. It’s not like you can go into class, say, “This is Monetary Policy”, and move on. There’s so much foundational knowledge that’s required. You have to talk about the Reserve Bank of Australia, the cash rate, the Australian cash market, money supply, domestic market operations…

It’s a lot.

So I’ve created a series to try and help teachers (and their students) build their knowledge about monetary policy. Start with this video here. Links to all the other videos are in the description.

I’d love your feedback on these videos if you use them. How did they go? Valuable? Things to add?

Monetary Policy? Start here.

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Monetary Policy is an extremely important but often complex part of Economics. 

I think the most challenging part of learning Monetary Policy is that so much of the content builds on more content and it only really makes sense at the end of the process.

This is often frustrating for students (and teachers). 

So, where do you start? If you’re an absolute beginner and you’re keen on learning the process of Monetary Policy, I’ve created a series of videos to take you step-by-step through the process.

Start here. This will set you up on a solid foundation. There’s also links in the description for the next videos in the series.

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.




Back to back rate cuts

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July 2019, Sydney: the Reserve Bank of Australia cuts the cash rate for the second consecutive month to 1 per cent.

Just for some context, during the Global Financial Crisis, the lowest the cash rate went was 3 per cent. 

Why did the RBA cut rates again? Let’s look at some highlights from the July statement.

Reason number one: Australian economic growth is weak

In terms of economic growth, the goal is around 2.5 to 3 per cent growth in gross domestic product (GDP) annually.

In the year to the March quarter of 2019, the Australian economy grew by only 1.8 per cent. According to RBA Governor Philip Lowe, “consumption growth has been subdued, weighed down by a protracted period of low income growth and declining housing prices.” 

Let’s analyse this quote. One, consumption is weak which leads to weak economic growth BECAUSE consumption makes up around 60 per cent of GDP. Two, low income growth and falling house prices reduce consumer confidence and their incomes, leading to more saving and less spending (because they are uncertain of the future).

So: cut rates, encourage spending and borrowing, and accelerate economic growth.

Reason number two: There’s a lot of unused or underused labour in the workforce

Dr Lowe also talked about how Australia has made little progress in reducing the amount of spare capacity in the economy. This particularly refers to unused or underused labour; what economists would call unemployment or underemployment.

As a result of the excess supply of labour, wages growth remains low. By cutting the cash rate, the RBA wants to see a fall in the level of underutilisation in the Australian economy (underutilisation rate = unemployment + underemployment).

Reason number three: Inflation remains below the target band

The RBA’s target band for inflation is 2-3 per cent over the course of the business cycle. Australia’s inflation rate hasn’t been within the target band, consistently for some years now (see graph below). 

Inflation hasn’t lived in the target band for some time now.

Inflation hasn’t lived in the target band for some time now.

By cutting the cash rate, the RBA’s trying to boost inflationary pressures in the economy.

Willl this rate cut actually work?

As an economics student, you can question the effectiveness of monetary policy. The RBA’s had an expansionary stance for some years now and there hasn’t been a huge boost to growth or inflation. 

Another point to consider is that fiscal policy could do more, right now, to stimulate the economy. Is it appropriate to run contractionary fiscal policy (move to a surplus) when the RBA is trying to increase economic growth? They’re working against each other. This is a question worth asking. 


Why did the RBA cut rates in June?

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Today, the Reserve Bank of Australia (RBA) cut the official cash rate by 0.25 basis points to 1.25 per cent. Why did they do it?

MY LIVE REACTION TO THE JUNE RATE CUT

You can read the full statement, which I recommend. You can also watch my live reax (on the right).

In short, the RBA cut rates for two main reasons.

1. The RBA cut interest rates to boost employment.

The RBA reckons that Australia’s labour market is pretty soft with substantial “spare capacity”. Spare capacity refers to unused resources, labour in this case, that are sitting around and NOT contributing to the economy.

According to the RBA, unemployment has increased and overall wage growth remains low — all indicators of such spare capacity. The RBA further believes that unemployment can go lower (as Governor Philip Lowe said in his statement, “the Australian economy can sustain a lower rate of unemployment”), and the central bank hopes that the reduced cash rate can help stimulate the economy and create more jobs BY reducing the level of spare capacity.

“Today’s decision to lower the cash rate will help make further inroads into the spare capacity in the economy. It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target. ”
— RBA Governor Philip Lowe

2. The RBA cut interest rates to boost inflation (back into the target band)

The RBA’s target band for inflation is between 2 to 3 per cent over the course of the business cycle. The central bank forecasts underlying inflation, which strips out volatile price changes, will only be 1.75 per cent in 2019, and touch the bottom end of the band at 2 per cent in 2020. By changing the cash rate, the RBA wants to move inflation back into the target band by stimulating consumption (because lower interest rates make it less attractive to save) and investment (because lower interest rates make it cheaper to borrow money and invest).

But why do we want to avoid low inflation? Isn’t high inflation a bad thing?

WHY IS LOW INFLATION BAD NEWS?

Low inflation is a problem for two reasons. One, if prices are low and expected to fall further, people will delay their consumption until prices are cheaper. But if they postpone spending, demand will fall and firms will require fewer workers and unemployment will rise and...it’s a bleak picture.

Two, low inflation relates to low wages growth. And if wages aren’t growing people aren’t spending and their living standards aren’t improving. This is not a great situation either.

The RBA has acted in June to stimulate consumption, boost employment and guide inflation back to more healthy levels. And the central bank isn’t finished yet! In a speech tonight, Governor Lowe suggested rates could go as low as 1 per cent, depending on economic conditions.

The difference between fiscal and monetary policy

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It can be tricky to distinguish between fiscal and monetary policy.

Let’s try and make it a bit easier.

Fiscal policy is all about the federal government’s use of the federal budget. It’s about the government changing government spending (an injection, the symbol is G) and taxation revenue (a leakage, the symbol is T) to affect the level of economic activity…and achieve other economic objectives.

Fiscal policy is budget policy.

Monetary policy is different.

Monetary policy involves the Reserve Bank of Australia’s (RBA) actions to alter the value of the cash rate to control the level of inflation (and affect economic growth). The RBA changes the cash rate to create changes in the general level of interest rates (set by the commercial banks) to deal with inflation and growth and employment and other challenges.

Big thing to note: monetary policy is government policy. But the government does not implement monetary policy.

Monetary policy is implemented by the independent RBA, on behalf of the government.

Fiscal policy: think about the budget.

Monetary policy: think about interest rates and the RBA.

Hope this helps. Try this video too.

The RBA gets its hands dirty

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Australia has a floating exchange rate. This means that the market forces of demand and supply determine the value of the $A. No-one can set an exact value for the $A.

But people still try to change the value of the $A.

The Reserve Bank of Australia (RBA), Australia’s central bank, intervenes in foreign exchange markets (the markets where foreign currencies are bought and sold).

Let’s take two scenarios. Let’s say the RBA thinks the $A is too high. The value of the $A is making exports too expensive (as buyers must purchase $A to buy Australian exports) and so they are less internationally competitive.

[International competitiveness is the ability of a nation to effectively sell its exports on world markets. If your exports are cheaper, it’s easier to sell them and so you are more internationally competitive.]

So, the RBA thinks the $A is too high. In this case, it will sell the $A and buy foreign currency instead. This will increase the supply of the $A and cause the currency to depreciate, hopefully to the level the RBA desires.

The second scenario is where the RBA thinks the $A is too low. In this case, the RBA will buy $A and sell foreign currency, which will increase demand for the $A and cause the currency to appreciate.

In this process, the RBA is intervening in the ‘clean float’. In economic terms, the RBA is ‘dirtying the float’. This represents direct intervention by the RBA to change the value of the $A.

Here’s a limitation. To dirty the float, the RBA needs large foreign currency reserves to push up the $A. This is because of the massive amount of $A traded each day. If the RBA’s reserves run dry, the central bank might struggle to support the value of the $A and the value of the local currency could fall rapidly.

Check out my video on this issue too.

AS A STUDENT, HOW CAN I USE THIS INFORMATION?

  • Be clear that Australia does not have a perfectly clean float

  • When you’re talking about exchange rates, make sure you mention that the RBA intervenes (when needed) to affect the value of the $A...and that this process is known as dirtying the float

  • Be ready to discuss the limitations of dirtying the float, namely the large amount of foreign currency reserves required to affect the value of the $A