Australian Outlook

In this section

Rising Global Inflation and the Challenges Facing Australia's New Treasurer

26 May 2022
By Dr John Hawkins
Source: Pixabay,

Australia’s current inflation, like that in much of the world, reflects a mix of temporary and more sustained factors and demand and supply issues. Navigating this new challenge will require agile economic management.

When incoming treasurer Jim Chalmers takes his seat in the treasurer’s office, one of the most important issues facing him will be the resurgence of inflation. At 5.1 percent, Australian inflation is the highest since the introduction of the GST in 2000. Measures of underlying inflation are running around 3.5 percent, the highest in more than a decade.

Most of his international peers face a similar conundrum. Inflation is around eight percent in the US, the Euro area, and the UK. It is five percent in India. Even Japan is facing more inflation — two percent is high by their standards. For much of the past decade no advanced economy had inflation over five percent; now more than half of them do. To make matters worse, the inflationary impetus is spreading across economies, affecting a wide range of goods and services.

Designing a policy response is complicated, as the inflation surge is driven by a mix of temporary and more sustained factors, as well as supply and demand issues.

The Ukraine Effect

The Russian attack on Ukraine triggered a surge in a number of commodity prices, taking them well above pre-COVID levels. The two countries account for over a tenth of the world’s supply of oil and wheat and over a third of palladium.

There are uncomfortable echoes of the 1970s when an underlying increase in inflationary pressures was greatly magnified by a supply-driven surge in oil prices. The failure to take decisive policy action allowed the higher inflation rates to become embedded in inflationary expectations. Inflation thus spread well beyond energy prices, and it took years to grind it out of the economic system. Generally, this required the application of tight monetary policy, such as during the Volcker shock of the 1980s in the US and Australia’s “recession we had to have” in the early 1990s.

One somewhat reassuring change since the 1970s is that the contemporary policy framework appears more robust. In the 1970s, many central banks were flailing after the Bretton Woods system of fixed exchange rates had broken down. Now most central banks have longstanding inflation targets with a record giving them credibility. For example, since the Reserve Bank of Australia adopted its 2-3 percent inflation target in the early 1990s inflation has averaged around 2.5 percent.

Furthermore, the reduction in energy intensity of the global economy should dampen the impact of oil prices on inflation compared to the 1970s. A recent estimate is that a ten percent rise in oil prices adds 0.2 percentage points to inflation in the average economy.

The COVID-19 Effect

Aggregate demand in the global economy has recovered faster from the COVID-19 recession than was the case in recoveries from recessions in earlier decades.

The pandemic was, however, associated with a mix of border closures (both internal and international), work absences due to illness, and cancelled flights, which meant that many markets experienced disruptions to supply chains.

Furthermore, as Reserve Bank governor Philip Lowe has noted, during lockdowns consumers were unable to go out and spend money on services such as tourist trips, restaurant meals, gym sessions, or cinema tickets. In many cases, their incomes were sustained by working from home or government support. So, they instead spent on ordering goods online, including home exercise equipment or fitting out home offices.

Higher demand and disrupted supply of goods had the effect of pushing up price of goods. These effects are likely to be transitory. But the risk is that they last long enough to pull up inflationary expectations.

The Global Monetary Policy Effect

The rise in inflation has led to central banks commencing a belated tightening in monetary policy. Interest rates are rising, and central bank bond purchases being unwound. Along with the disruptions from the Ukraine war, this is likely to see some reduction in global economic growth. Indeed, the IMF’s latest forecasts have already revised down their forecasts for global economic growth in 2022 by 0.8 percentage points.

Longer-Term Influences

The general manager of the Bank for International Settlements, Agustín Carstens, recently warned that “the structural factors that have kept inflation low in recent decades may wane as globalisation retreats.” Carstens was concerned that the pandemic and geopolitical concerns may lead firms to rely less on global supply chains. Furthermore, while inflationary pressures were mitigated in recent decades by an increase in the effective global labour force as China and India opened up to the world, this will not continue, at least not at the same pace.

Differences in Australia

While Australia is facing many similar influences to the rest of the world, the situation facing Dr Chalmers is not as dire. Energy prices have not risen as much as in Europe and the US. Supply chain problems have been less severe as there has not been the “great resignation” from the workforce seen in the US. And at least so far, there has not been a marked acceleration in the cost of labour.

The double-digit percentage increases in the prices of beef, vegetables, dwelling purchases, and petrol  in Australia over the past year are unlikely to be repeated over the next. So, there is hope inflation will soon peak. But it will need some agile management.

Dr John Hawkins is a senior lecturer at the Canberra School of Politics, Economics & Society, in the University of Canberra.  He has been a senior economist at the Reserve Bank of Australia, Australian Treasury and Bank for International Settlements and secretary to the Senate Economics Committee.

This article is published under a Creative Commons Licence and may be re-published with attribution.