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Australia’s cost of living crisis is hurting ordinary households, and it won’t be over soon

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March 28, 2022
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March 28 (The Guardian) – The cost of living crisis undermines the preferred election year narrative of a solid recovery from the pandemic. Politicians, irrespective of ideology, now find themselves trapped by rapidly moving events mostly outside their control.

First, despite central bank messaging about transitory, low and gradual inflation, Australian consumer prices are rising at 3.5% annually with increases expected to accelerate.

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But the true figure is probably higher. One estimate puts actual US inflation at roughly double the official 7.9%. The Reserve Bank of Australia’s preferred trimmed mean inflation figure ignores 15% of the highest and lowest price rises. In the 1980s, a Latin American finance minister defended excluding items whose price had gone up sharply on the grounds that no one could afford them.

Second, current inflationary pressures reflect an unusual combination of demand and supply factors, many of which are likely to persist.

Demand has been underpinned by pent-up post-lockdown spending, low interest rates and central bank liquidity. Financed by central bank bond buying, government spending (sometimes poorly targeted) has substantially exceeded declines in income during the lockdowns.

READ: Pakistan’s Imran Khan tries to pull off a come-from-behind victory

Simultaneously, short and long-term supply issues, now exacerbated by the Ukraine conflict, have created shortages of commodities, goods and services. Oil prices have risen five-fold since the artificial lows of 2020 due to energy politics and a poorly planned and executed energy transition to renewables. Higher food prices reflect extreme weather, especially droughts and floods.

Supply chains have still not fully recovered from isolation requirements, mobility restrictions and border closures which disrupted production and transport links. As long as China’s zero Covid-19 policy continues, periodic interruptions of factories and ports are possible. Geopolitical tensions between the west and China and, now, Russia and associated trade restrictions and sanctions have affected trade, technology transfers and investment flows.

READ: India hikes petrol and diesel prices for the fifth time in 6 days

All these factors result in higher prices, delays and increasingly unreliable availability.

Third, policymakers lack the tools to bring inflation under control, at least quickly. Standard operating procedure is to suppress demand to match production. But winding back government spending, increasing rates and reversing loose monetary policies may jeopardise a fragile recovery in an economy addicted to stimulus and facing other hazards.

Actions, such as a one-off payment to the worst affected or reducing taxes on fuel, will have limited and short-term impact. If not offset by adjustments elsewhere, they will add to – not reduce – demand, increasing price pressures and may worsen public finances.

Increasing interest rates is problematic. With inflation high, to be effective, central banks would have to rise sharply – by at least 4 to 5% – to normalise real interest rates. In the “everything bubble”, such increases could trigger lower real estate and share prices, far beyond the relatively modest corrections experienced since late 2021. It would also increase interest expense on the high level of government, business and household debt, especially mortgages.

Financial distress for over-stretched borrowers risks a new financial crisis. This means any rate rises will have to be carefully calibrated to avoid side effects, limiting their efficacy.

Policy options on the supply side are limited. Financial finagling cannot control the pandemic, eliminate extreme weather, increase production of goods and services, or bridge geo-political divides. Governments can help expand essential infrastructure and correct workforce shortcomings but it will take years.

The only other option – mandatory government price controls – has proved ineffective in the past. Where the market price is capped artificially, hoarding increases, black markets spring up and resources are diverted to seek better returns elsewhere.

Finally, while paying lip service to price stability, government and central banks may have a higher tolerance for inflation for several reasons.

Authorities have spent nearly 15 years trying to increase inflation to avoid deflation which could damage a debt-laden economy. Higher prices boost economic activity by encouraging consumption as buyers accelerate purchases fearing rising costs. Inflation is also helpful in dealing with the high levels of borrowing. It increases tax and business revenues to help meet debt repayments. It also reduces purchasing power, lowering real debt levels. It allows a stealth lowering of living standards and devalues the currency thereby increasing Australian international competitiveness.

With wages unlikely to keep pace with this increase in prices (Bank of England Governor Andrew Bailey controversially asked Britons not to request a raise this year despite the threat of runaway inflation), the cost of living crisis is unlikely to abate soon, hurting ordinary households and exacerbating inequality, irrespective of who voters put in charge.

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