‘Temporary inflation episode’, so history doesn’t repeat: RBA

With cash-rate changes to combat high inflation commensurate with what the latter’s doing at the time – economists and pundits alike got a heads-up to buy tickets for the economic roller-coaster ride ‘probably’ heading Australia’s way – over next few years, at least - according to Reserve Bank of Australia on Tuesday (22 November).

Speaking at the Committee of Economic Development of Australia (CEDA)’s dinner event in Melbourne,  RBA governor Philip Lowe – in probably his last official 2022 statement before the cash-rate announcement on December 6 – said much the same in recent months, but this time with a twist.

That is, depending how the timeframe is interpreted, he emphasised the importance of ensuring “this episode high inflation is only temporary”, while underling that it “might be more variable over the years ahead” and discussing the implications of this for economic policy to come.

“For most of the past decade the issue was that inflation was a bit too low, not too high. And for the couple of decades before that, inflation varied from year to year, but averaged two and a half per cent in Australia,” Mr Lowe explained.

“An inflation rate of 7 or 8 per cent was something that was widely thought to be consigned to the history books, so the current bout of high inflation has come as quite a shock,” he said.

After re-iterating inflation was a ‘scourge’ and flashing back 60 odd years covering the fluctuating trajectories of Australian inflation, Mr Lowe resolved and reminded how in the 1970s and 1980s said scourge damaged the Australian economy and “hurt our living standards” and had made it “harder for businesses to plan and invest.”

He explained: “The high inflation undermined our prosperity; it eroded people’s savings, distorted resource allocation and increased inequality in our society.”

“This experience also put paid to the idea that by allowing more inflation, we could have more growth and jobs.

“Rather, the reverse was true. High inflation meant lower growth, fewer jobs and lower real wages,” he said.

Yet perhaps the most poignant lesson learned over these past decades was that bringing inflation back down again after it becomes “ingrained in people’s expectations” is “very costly and almost certainly involves a recession.”

With the R word mentioned, it set the stage for explaining current central bank measures and why such would be taken and under what changing circumstances they would and could be applied.

The central bank clarified its forecast that inflation will peak later this year at around 8 per cent and then “decline gradually over the next couple of years to be a little above 3 per cent by the end of 2024.”

The reasons behind the expected decline are: COVID disruptions to supply being resolved; commodity prices have stabilised and in many cases declined; plus thirdly interest rate increases around the world and for Australia “will result in slower growth in aggregate demand”, in time leading to “less pressure on capacity and lower inflation.”

Such was the theory, but an RBA caveat remined that: “As always, there is uncertainty around this outlook,” Mr Lowe stated.

A longer term prognosis

Interestingly, the RBA has highlighted other factors that are “likely to create more variability in inflation” than Australia had become used to.

These are: higher costs and less supply flexibility driven by a “reversal of globalisation”, as trading blocs are emerging and “there is a step back from closer integration”; the working-age population now declining and the decline projected to accelerate; increasing climate-related events disrupting commodity production, prices and the transport and logistics industries; and finally quickly depreciating capital stock used to produce energy while a significant-investment transition to ‘green’ energy takes place.

“All four of these supply-side developments are first-order issues that are likely to affect the environment for Australian business over the years ahead,” governor Lowe explained.

“They are also likely to affect the inflation dynamic here and elsewhere, leading to more variability in inflation from year to year.”

Average Aussies feeling the pinch

In concluding and giving any possible insight or respite into what December’s impending cash-rate decision will be, for many listening to the speech at CEDA such reassurance leading into the festive season would not eventuate.

Though Mr Lowe did acknowledge the central bank understood that many people are finding the rise in interest rates difficult, he outlined that it is necessary “to ensure that the current period of higher inflation is only temporary.”

“As I spoke about earlier, if high inflation were to persist, all Australians would pay a heavy price,” he warned.

“Given our mandate for price stability and full employment, the board expects to increase interest rates further over the period ahead.

In a disclaimer of sorts, he reminded: “We are not on a pre-set path though.”

“We have not ruled out returning to 50 basis point increases if that is necessary.

“Nor have we ruled out keeping rates unchanged for a time as we assess the state of the economy and the outlook for inflation.

“The board’s priority is to return inflation to target over time,” he confirmed.

[Related: Labour market agility via housing shake-up needed: CEDA]