Record-breaking run on inflation in sight

As it contemplates what has been an extraordinarily white knuckle few weeks for the global economy (courtesy of the insanity of sections of the Republican Party), at least one thing the Reserve Bank of Australia Board is  unlikely to worry about when it meets in a couple of weeks is domestic inflation.

The September quarter Consumer Price Index figures due out on Wednesday are expected to confirm that, whatever else might be going on the economy, it’s not happening in prices.

If they show, as tipped, that underlying inflation increased by around 0.5 per cent for the quarter, it will mean the nation is heading into the fourth consecutive year in which price pressures have been contained within the 2 to 3 per cent target band set by the central bank.

Since mid-2010, annual growth in underlying inflation has not reached any higher than 2.85 per cent, and has remained stuck around 2.4 per cent for more than a year.

Laudable as this result may be, it is not really remarkable.

In the sweep of time since the recession of the late 80s/early 90s and the establishment of an independent central bank, inflation has been largely well behaved – apart from a few quarters following the introduction of the GST in 2001 and the growing pains caused by the resources boom during 2007 and 2008 (see RBA chart below).

Underlying inflation 1993-2013 - RBA

If the RBA is correct in its view that inflation will remain within its target band for at least the next two years, it will mean more than five years of moderate price growth – a record-breaking achievement, exceeding the previous high of four consecutive years from mid-2002 when annual underlying inflation stayed between 2 to 3 per cent.

For a central bank which has as part of its mandate the containment of price pressures, this will be a signal achievement.

It also means that politicians may have to update their rhetoric and ditch the trusty old trope of “household cost of living pressures”.

For all the talk about cost of living pressures, there is little sign of them in the figures.*

* There is an argument to be had about whether the Australian Bureau of Statistics, with its CPI methodology, accurately encapsulates what households spend their money on, but this is a subject for a future post.

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2 Comments

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2 responses to “Record-breaking run on inflation in sight

  1. Rob

    As usual, a very thought provoking article. A few observations:
    It is a very long bow to draw (which I believe is implied) that the establishment of an independent central bank is somehow correlated with low inflation. Without going into detail, it is fair to say the 1970s and early 80s were atypical inflation periods. The 1950s was generally a period of low inflation and the notion of central bank independence hadn’t seen the light of day. There is no way of knowing what inflation would have been without an independent central bank. Indeed, as the actions of the commercial banks illustrate, lending rates are increasingly set by market forces and not the central bank.
    Trivial, but important, the introduction on the GST raised the price level, but not the inflation rate, as there was little or no feed-through to wage settings.
    Certainly inflation remains an issue, but it hasn’t been a problem for many years. One wonders what the “best” rate of inflation should be. Thoughts?

  2. Hi Rob. You are right that it is important not to make too much of the establishment of central bank independence and the decline in inflation in the early 1990s – it was already heading lower well before Canberra made that move (and there’s nothing like a recession to bring galloping prices to a screeching halt).
    The link between official interest rates and commercial lending rates is an interesting one. The relationship is much less direct than it once was, but in the mortgage market changes in official interest rates are still used as a reference point – if only to compel those who decide to chart their own course to explain themselves. One of the question
    I’d appreciate your thoughts on is whether this is a permanent and irrevocable state of affairs, or not.
    As to what rate of inflation would be ‘best’, this is really where the political demons come home to roost for central banking. It’s little wonder that the RBA is keen to get each Government to explicitly endorse the inflation target.
    Getting away from the aggregate inflation measure, obviously inflation for individual items is an important artefact of the ebb and flow of demand – price signals are integral to a functioning market, so the question becomes more one of what is the source of inflation, and is it a product of some intervention or distortion or failure in the market, or does it best reflect supply and demand. As you can tell, this is something I’ve still got to put a lot more thought into. Thanks for getting me to ponder it, and I welcome any thoughts and insights you might want to add.

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