Inflation will reappear in Australia – but that shouldn’t mean the end of stimulus
Over the next few months we will see some pretty extraordinary inflation, which the Reserve Bank and the government should ignore as a false sign of a strong economy. They should remain clear that more stimulus is needed.
If there is one guarantee in economic debate, it is that as soon as any sign of economic strength occurs, conservative commentators and politicians will start worrying about inflation.
The Economist has run an article wondering “How much of a worry is inflation?” The New York Times suggests “Inflation fear lurks, even as officials say not to worry”, the Wall Street Journal attempted some balance by wondering “Is inflation a risk? Not now, but some see danger ahead”.
Meanwhile, here in Australia, the Australian decided in March we needed to know that “John Howard warns about nightmare of inflation” and the Financial Review on Monday ran an op-ed headlined “‘Giddy’ government spending means inflation threat is real this time”.
Yes, we were wrong all those other times but this time trust us.
It reminds me that in 2009, after the Obama stimulus, Arthur Laffer (he of the Laffer curve) wrote that the United States could “expect rapidly rising prices and much, much higher interest rates over the next four or five years” (spoiler, they didn’t).
In the next few months there will be signs of rising inflation. The June quarter of this year will almost certainly see the fastest price rises for a decade.
But it is not the inflation genie being let out of the bottle (to use former treasurer Wayne Swan’s phrase of 2008); it is just that last year prices actually fell – so by comparison anything is going to look like a surge:
Graph not displaying? Click here At such times you really want to keep your head and not go chasing rabbits.
It will be much better to focus on the Reserve Bank’s underlying inflation measure, the “trimmed mean”, which does not get so excitable:
Graph not displaying? Click here
But we also need to realise that these “fears” are really about the same thing they were during the GFC – government stimulus and debt.
We see this when commentators get conniptions about government debt because, gosh golly, government bond
yields have risen sharply – just think of our debt repayments!
And yes, they are right. A year ago, when the fears of the pandemic were at their highest, the interest rate (or yield) for Australian government 10 year bonds was just 0.86%, and last month it averaged 1.69% – my God, that’s nearly double!
Graph not displaying? Click here
But let’s get some perspective – that level is still lower than any ever recorded before May 2019, and it is less than half the 4% rate the Rudd government had to pay on its stimulus loans during the GFC.
And just a reminder: in last year’s budget, the government estimated that its debt was going to more than double, yet annual interest payments as a percent of GDP were expected to fall:
Graph not displaying? Click here
But inflation worry-warts will tell you that if inflation keeps rising and government bond rates go up ever more, before you know it our debt repayments will make the government look like a condo-owning dancer from The Big Short.
But government bond yields historically follow inflation:
Graph not displaying? Click here
The link only really broke in 2019 when the weak global economy and already low interest rates saw bond yields go well below what is really possible for inflation to be at for any length of time.
And the relationship between bond yields and future inflation is also quite solid. Inflation expectations remain very low – even if they are higher than the absurd levels of last year:
Graph not displaying? Click here To suggest that we are about to have a surge of inflation is also to suggest the Reserve Bank will sit by and do nothing even as prices keep rising.
But let’s also remember the other aspect this argument is really about – wages.
Apart from a massive supply shock (such as a huge rise in petrol prices), inflation only rises because wages rise – people have more money to spend and so buy more and thus businesses raise prices.
And conservative commentators and politicians who spread fear of inflation never want wages to go up.
The Australian on Monday ran an editorial supporting its front page story on businesses arguing against a minimum wage pay rise, by asserting that “Pricing workers out of jobs would hold back recovery”.
For prices to rise at anywhere near the levels that would see inflation grow above the Reserve Bank’s 2-3% target rate, wages would need to grow consistently above 3.5%, and probably closer to 4%:
Graph not displaying? Click here That hasn’t happened for over a decade.
Inflation breakout? Hardly.
We want prices to go up because we want increased demand in the economy and we want wages to go up.
And we should pay little heed to those worrying about inflation getting out of control when what they really are worrying about is governments stimulating the economy and anything being done to raise the wages of workers.