Life on the West Island - Slaying the dragon

Lately, there has been much talk on the West Island about rising inflation being the enemy which is dragging us inexorably into economic crisis by raising the cost of living, while real wages continue their decade-long fall. The federal treasurer and many learned commentators have agreed that we must “slay the inflation dragon.” But will that actually make life better for ordinary citizens? Life on the West Island has some doubts.

Let’s start with how we measure inflation on the West Island – the Consumer Price Index (CPI). The Australian Bureau of Statistics (ABS) has a complex website which more or less indicates the types of consumable goods and services included in the CPI, but which does not detail those everyday costs to households which are excluded. But if you wade through all the supporting documentation, you will eventually find that the CPI excludes existing dwellings, the cost of land, and mortgage interest charges. ABS also says that the CPI measures price change for a selected basket of goods and services that households consume. Land prices are excluded from the CPI as it is classified as investment not consumption.

What this means is that the West Island measure of inflation does include rising costs of new homes, but not existing ones, which have skyrocketed in the last three years -although prices are currently declining a little. Further, the CPI excludes one of the fastest-rising costs in many households – mortgage repayments, which then also flow on to costs of rent and short-term accommodation. These excluded items are central to the cost of living crisis facing the nation.

In this context, we have the great battle against inflation being fought by the dragon-slayers in the Reserve Bank of Australia (RBA). Economist Michael Pascoe questions this:

The Economics 101 picture the RBA paints of inflation fighting doesn’t tell near the full story. The people suffering from the supposed cure might rebel if they did. What’s missing is the mess of conundrums that plague the textbook central bank response of boosting interest rates to dampen demand by weakening the economy, increasing unemployment, shrinking real wages and sending some businesses broke.

Unlike the real-world experience, reducing inflation all sounds rather academically clean and remote in the RBA Governor’s post-meeting statement. It doesn’t acknowledge the conundrums inside the monetary puzzle, starting with what “tightening monetary policy” means: Pushing up the price of money. Pushing up the price of something? Isn’t that inflationary? Yes, but the RBA pretends it is not. Interest rates are not included in the RBA’s benchmark, the Consumer Price Index.

The rising price that certainly is in the CPI and getting all the attention at present is the cost of energy, but if you think about it for a moment, higher electricity bills do pretty much the same thing as higher interest rates: Suck money out of people’s pockets so they can’t buy as much other stuff, reducing overall demand in the economy.

In one way, pushing up the price of energy is more democratic than pushing up the price of money – only about 35 per cent of households have a mortgage through which to feel monetary pain, but just about everyone cops energy bills. But in another way, squeezing the life out of the economy through more expensive energy is less fair as it is highly regressive – a larger proportion of poor people’s income goes on energy than that of wealthy people.

For years, the RBA has wrongly forecast an imminent rise in real wages. Their latest statement says that wages growth is continuing to pick up from the low rates of recent years, although it remains lower than in many other advanced economies. A further pick-up is expected due to the tight labour market and higher inflation. Given the importance of avoiding a prices-wages spiral, the board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead.

This statement shows just how much the RBA is out of touch with reality. A modicum of research will show that at least since 2015, real wages have continued to fall and that every forecast of them rising has been wrong.

Treasurer Jim Chalmers painted his budget last week as being on the same page as the RBA in wanting to fight inflation first – but he also wants higher wages and a fight is erupting between the government and business over industrial relations changes designed to increase them.

Pascoe points out Another conundrum: the mining industry apparently wanting to lead the fight against higher wages. Thanks primarily to the windfall profits being enjoyed by the mining sector (yes, that includes oil and gas) shows compensation of employees’ share of factor income falling to its lowest level since the ABS started keeping score while profits’ share is at its highest ever.

In the face of this, the RBA has quietly dropped its aspiration for higher real wages. The Bank’s position is fixated on slaying the inflation dragon as the only cure to the West Island’s economic crisis, as made clear in the last sentence of its recent statement: The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that. In fact, all the RBA is doing is adding to inflation by pushing up the price of money. Perhaps rather than slaying the dragon, it is lighting its fire? Meanwhile, in the real world, the cost of living goes up and up…