Our inflation problem is not a big problem

Various economists argue that the price increases have been “wide” in order to show that the price increases are now “demand-driven”, but the main reason why so many prices have increased is that there have been so many different supply shocks coming at the same time, with so many indirect effects, from transportation costs to fertilizer and food.

Two-thirds of the quarterly price increase came from four items. In order of effect on the index: cost of new housing (up 5.7%), fuel prices (11%), university fees (6.3%) and food (2.8%).

Of these, only new home prices can be attributed primarily to strong demand, stemming from the now-completed HomeBuilder stimulus. The tuition increase was a decision of the Morrison government.

The US economy is “overheating”, but not ours. It is true that our job market is very tight and much of this strength is due to our now abandoned stimulus measures.

But, paradoxically, the economics profession’s ideological commitment to growth through immigration has blinded it to the obvious: job vacancies are at record highs also due to another constraint of pandemic-related supply: our economy has been closed to all imported labor (and we have even sent a good part of it home). This constraint has already been lifted.

The problem with supply shocks is that they are one-time and not permanent. So, left to himself, without further away shock him rate of the price increase should subside over time. Gasoline and diesel prices, for example, have already fallen a little but, in any case, they will not continue to increase by 35% per year, year after year.

Gasoline prices have started to come down a bit.Credit:Jason South

It is sloppy thinking to think that a rise in prices equals inflation. The public can be forgiven for such a fundamental error, but professional economists cannot. A real inflation problem only arises when the rise in prices is widespread and continuous. That is to say when it is maintained by a wage-price spiral.

When a huge price hike, from whatever source, leads to an equally huge – or bigger – increase in wages, which leads to another round of price hikes. It is inflation.

In their panic, business economists assumed that the loss of employee bargaining power we’ve seen for most years since the global financial crisis, which did so much to confuse economists’ wage and growth forecasts, and pushed inflation below the Reserve’s target range for six consecutive years, has suddenly transformed. Union activism is back!

Really? I’m sure the employees and what’s left of their unions will be asking for wage increases of at least 5% this year, but how many will get that much? They’ll all be on strike until they do, you think?

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According to the Wage Price Index, they are sure to get more than the 2.3% they got in the year to December, but the greater likelihood is that real wages will continue to rise. to lower. And the cure for that is to raise interest rates, right?

It is true that, if wages have increased in line with prices, we would like to have an inflation problem, but how likely is it to happen?

There has been much concern about stopping a rise in “inflation expectations”, but this thinking involves a two-step process: in anticipation of higher inflation, companies raise their prices. And in the expectation of higher inflation, the unions are increasing their wage demands.

All the saber rattles we’ve seen from top retailers and their the employer equivalent of union bosses – so gasped by the media – suggests they are increasingly confident they can get away with big price hikes. But it remains to be seen how successful individual employees and unionized workers are in achieving their expectations.

Perhaps in this more inflation-sensitive environment, employers will be far more generous — more caring and more generous — than they have been for the past decade. Perhaps.

The Reserve is under immense pressure from financial markets, bank and corporate economists, the media, stocks of other central banks and even the International Monetary Fund to start raising interest rates.

It will, with little delay. You have to see him act. But whether this is in panic stations with the media and business economists is doubtful. And you don’t have to believe the inflation genie came out of the bottle to see that the need for interest rates to be at near-zero emergency levels has passed.

As BetaShares’ David Bassanese predicted, the Reserve “will not actively try to slow the economy, but rather [will] begin the process of interest rate normalization now that the COVID emergency has passed.” The shift to “quantitative tightening” will be part of this process.

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