Inflation is really low in Australia. Why?

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.