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The government must look for ways to lower inflation with the burden of rapidly rising interest rates having an unequal impact across households.
Australian inflation continues to remain high despite a rapid increase in the cash rate, with consumer prices still at a 33-year high, said AMP deputy chief economist Diana Mousina.
The Reserve Bank of Australia has been focused on reducing inflation using the main policy tool it has available – interest rates.
“The cash rate has risen from 0.1 per cent in April 2022 to 4.1 per cent in June – a 4 per cent lift in just over a year. But, the impact on inflation so far has been lower than expected,” said Ms Mousina in a recent AMP article.
This raises questions around whether the interest rate rises are having a sufficient impact on inflation and whether there are better tools available to policymakers, especially as interest rate hikes are having an unequal impact across household groups.
“Some might say that rate hikes should have worked faster or better by now to reduce inflation. The problem has been that there have been numerous supply-driven elements of the inflation story that have been less sensitive to interest rate changes,” said Ms Mousina.
Interest rate hikes have led to a slowing in consumer demand which has helped to reduce inflation but there are concerns that rate hikes should have worked faster or more efficiently by now to reduce inflation.
“The problem has been that there have been numerous supply-driven elements of the inflation story that have been less sensitive to interest rate changes,” explained Ms Mousina.
“Covid-driven supply chain disruptions led to big increases in shipping costs, commodity prices like energy, metals and agriculture increased significantly in 2021-22 mostly from supply disruptions, domestic energy supply issues led to an Australian energy crisis and multiple domestic floods led to higher food prices.”
While these issues may not be directly influenced by the level of change in interest rates, it is the responsibility of the RBA to ensure that supply-driven price changes do not leak into consumer prices, said Ms Mousina.
A lot of these supply-related issues are now resolved, but it takes time for it to be reflected in the final inflation figures, she noted.
Australia’s energy crisis occurred later relative to the Northern hemisphere due to a raft of domestic issues like supply challenges with coal, a poor national plan for the energy transition and higher global prices.
Mortgage holders bearing the brunt of monetary policy changes
The impact of monetary policy works primarily through the lending channel as borrowing rates are priced off the cash rate.
“Households with a mortgage are the most impacted by interest rate changes,” said Ms Mousina.
“Businesses and individual investors are arguably less impacted because they can deduct the debt interest expenses. There are also other financial market channels that monetary policy works through, mostly through the exchange rate.”
The high level of household debt now means that mortgage holders are the most heavily impacted by monetary policy changes.
“Renters can also be affected from higher interest rates if landlords are able to pass on the higher cost of debt servicing through higher rents,” said Ms Mousina.
“This is only usually an option in a tight rental market which the current situation is allowing for.”
In Australia, 37 per cent of households have a mortgage based on data from 2019-20, 29 per cent rent and 30 per cent own their own outright.
Detailed ABS data on housing costs shows that households with a mortgage spend close to 16 per cent of their gross household income on housing costs including mortgage or rent and rate payments as at 2019-20, owners without a mortgage spend 3 per cent of their income on housing costs and the average renter spends close to 20 per cent of their income on housing.
“There are divergences across income quintiles with the lowest income quintiles spending a very large share of income on housing costs,” said Ms Mousina.
The high degree of supply-related factors that have increased inflation, the slow reduction in prices despite aggressive interest rate hikes and the high burden placed on households with a mortgage has led to questions about whether there are other options available to reduce the level of inflation, she said.
The government has more tools at its disposal compared to the RBA through its spending and taxation decisions as well as regulation.
Ms Mousina noted that these tools are slow moving and therefore don’t have much of a direct impact on inflation.
“[However], the government does have a role to play in many components that impact inflation, such as ensuring a well-regulated electricity market, sustainable outcomes for minimum award and public sector wages which set the tone for the rest of the market, ensuring that fiscal policy (both state and federal) is appropriate for the state of the economy,” she said.
“While the impact of the May Federal budget is more or less neutral but with the addition of some state cost of living benefits it could be marginally inflationary and the government could consider raising taxes to help get inflation dow,” she said.
The government should also look at the regulation of retailers to ensure adequate competition and ensure adequate housing for the migration targets.
Jack Campbell
Jack is the editor at HR Leader.
