Are rate rises the only way to stop inflation?

The RBA has held off on raising the cash rate – for now. This comes as a sigh of relief to home owners, who have slogged through 12 rate rises since May 2022. But with warnings of further rate rises, many people are questioning whether they’re the only way to stop inflation.

Listen to Trent Wiltshire, Deputy Program Director of Economic Policy, and Joey Moloney, Senior Associate, discuss how to stop inflation with host Kat Clay.

Transcript

Kat Clay: The RBA has held off on raising the cash rate for now. This comes as a sigh of relief to homeowners who have slogged through 12 rate rises. Since May, 2022, but with warnings of future rate rises ahead, many people are questioning whether they’re the only way to stop inflation. Now we are going to get a little bit wonky on this podcast, talking about monetary and fiscal policy, but we’ll do our best here to keep it understandable and relevant to what’s going on in the Australian economy.

I’ve got two of Grattan’s experts in the field here to help. Trent Wiltshire, Deputy Program Director of Economic Policy, and Joey Maloney, Senior Associate. Joey, let’s start with the basics. What is inflation? Where does it come from? And why is it bad?

Joey Moloney: Inflation is sort of an economy wide increase in prices.

Now, we can have increases in prices in individual markets. So think of a cyclone in Queensland disrupting banana plantations, banana prices go through the roof. They eventually come back down. What inflation is, is that kind of havoc happening on average across most markets. So what that means in aggregate is it’s an imbalance between The aggregate supply of goods and services available for people to buy, and the aggregate demand, so the amount of goods and services that people want to buy.

Now, high inflation is bad for a few different reasons. Key reason is, it diminishes people’s purchasing power. What that means is that your dollar doesn’t go as far as it used to. You can’t buy as many things with your dollar as you used to be able to, which means that the value of your your take home pay or whatever your income is diminished.

What that also means is it erodes the value of people’s savings. So if you had five grand saved in May last year, sort of when the inflation really started, that’s worth less today because you can’t buy as much with it. The big danger with high inflation is it persists and can even accelerate. So if saving, if, if it’s eroding the value of people’s savings and discouraging savings, then that might mean More money that is spent on goods and services, which means that represents an increase in aggregate demand, which can make the problem worse again.

The other mechanism is that, as people see the value of their take home pay being diminished by inflation, that can flow through to higher wage demands. You know, wages try to chase inflation. Now that can lead to an acceleration of inflation. That’s probably not what Australia is experiencing at the moment, but it’s something that policymakers are really cognizant of because it’s a real, real danger, you know, there’s episodes in history of.

Inflation accelerating out of control to the point where you get something called hyperinflation which basically just debases the entire economy.

Kat Clay: I was going to say, I still remember my year 12 history lessons about, you know, hyperinflation and obviously the rise of Hitler in Germany. So, so it’s something that has happened before in history.

I mean, we’ve got you know, the high the low unemployment rate at the moment as well. So it sounds like that’s fueling inflation too.

Joey Moloney: Yeah, a tight labor market is certainly representative of a hot economy, and a hot economy is one where in which there is high aggregate demand. Aggregate demand outweighing aggregate supply is fundamentally what causes inflation.

So, you know, those episodes you were talking about, the forecasting history. Where, you know, accelerating inflation kind of can destabilize an economy and then can destabilize the society is why, you know, central banks in most developed countries are focused on maintaining low and stable inflation because it’s a necessary condition for economic growth.

Now, it’s not a sufficient condition, but it’s necessary. So that’s why it’s the focus of central banks. But we’re lucky enough to be joined today by, you know, a former employee of our central bank here in Australia. Low and stable. Inflation’s not quite what we have right now, Trent.

Trent Wiltshire: Yeah. Looking at the, the current data, we see that inflation’s still very high.

It is coming down a bit, but it’s still well above the RBAs target range of two to 3%. So the monthly CPI indicator, which came out a few weeks ago had headline inflation at 5.6% year on year. So that’s fallen from about 6.8%. So it is coming down but the underlying rate of inflation, so that’s what the RBA really cares about.

So that’s when you strip out the volatile items, and there’s a few ways you can do that. But the different measures of that in this monthly CPA indicator range from 6. 1 to 6. 4%, so still high and looking pretty persistent. So you can see that in the services inflation, which is quite a persistent measure, that’s still very high.

The most recent full consumer price index data we have is from the March quarter, so it’s a little bit dated now. That had inflation at 7 percent year on year, and again, the underlying rate of inflation at 6. 6%, so yeah, still well above that 2 3 percent target range. What’s been driving this high inflation?

Well, over the past year, It has been mainly a supply side story. So those supply side shocks such as the COVID 19 supply chain disruptions, you know, they’re ending, but they still lingered quite a bit in 2022. The Russian invasion of Ukraine that, you know, puts up energy prices. Australia, all these factors were held back the supply side.

And they contributed to higher inflation. So the RBA estimates that those supply side factors contributed at least a half of our inflation. So, you know, a big part of it, but even if you take that out, the demand side drivers of inflation. It still meant the inflation rate would have been over 3%, so still above target.

So while it was a supplier side story predominantly, strong demand was still a factor. And looking forward, it does seem like the demand side is going to be the driver of inflation. So that’s what the RBA can control directly through interest rate changes. So that is demand side factors. higher wages, the tight labor market Kat and Joey just talked about.

That’s what the RBA is probably worried about in terms of inflation persisting above the band. So that’s why the RBA is probably forecasting extended period of above target inflation. It flows through to inflation expectations. So if inflation is high and people expect it to remain higher. That actually drives inflation higher.

So it’s a very much expectations driven game. So that’s why the central banks and the reserve bank care about credibility. The fact that people trust that the RBA will get the inflation rate back down to its target range.

Kat Clay: Mortgage holders across the country are kind of really concerned every time the cash rate goes up.

Why and how do you hire interest rates?

Trent Wiltshire: It’s a fair question because it does seem a little bit counterintuitive at some stage. We’ve got rising inflation and the RBA is pushing up a major cost to many households. That seems like it’s sort of working against the, the aims of bringing inflation down. But the mechanism is that, so the RBA uses its cash rate, which is what it can control directly to influence interest rates.

across the economy, paid by, paid by households and businesses. So these interest rates affect aggregate demand and therefore employment across the economy. So, the RBA’s mandate is to maintain the stability of the currency, full employment, and to promote the economic prosperity and welfare of Australia.

So those broad objectives have been narrowed down to what they call inflation targeting. So, The RBA aims for two to three percent inflation on average over the medium term, while also considering what’s going on in the labor market. So these higher interest rates, at the moment we’re seeing interest rates obviously rising quite rapidly.

They impact demand through a number of what are known as interest rate channels or monetary policy channels. channels. So first there’s the savings and investment channel. So high interest rates mean there’s a higher incentive to save and disincentive to borrow and invest. So that drives down aggregate demand.

The wealth channel, so when interest rates rise, that generally pulls down or lowers asset prices. So think of house values. When people’s assets are worthless, they’re less likely to spend. So that drives an aggregate demand. The cashflow channel, this is the most talked about one. So quite simply, high interest rates means higher mortgage repayments.

So it means people have less money to spend on other things. So that pulls down aggregate demand. So you think about Australia, there’s about one third of households have a mortgage. That’s over three million households. Australia has a high proportion of variable rate mortgages. So the interest rate changes directly or quickly affect mortgage holders, more so than lots of other countries.

So that’s a really important channel, but it’s not the only one. And then another channel is the exchange rate channel. And this is actually really important. It’s just not talked about much. Probably because the losers or the impacts are more broadly spread. So it’s not as, as harshly felt by individuals, but that’s.

When the Australian when interest rates rise here, Australian dollars are more attractive for overseas investors and that pushes up the Australian dollar, which reduces exports, making imports cheaper, which flows through to lower inflation, but importantly for the exchange rate channel, it depends on the relative interest rates.

So our interest rates compared to other countries. So if everyone’s tightening and we’re not, that means it’s not, it’s not working as well as it should have. So at the moment that’s somewhat the case. So our cash rate is at 4. 1%. Look at our peers and our major trading partners. So it’s 4. 75 percent in Canada, New Zealand’s 5.

5%. The U. S. is 5. 125%, so we’re below our peers, so that’s potentially actually having, if we don’t keep raising rates, that’s having a depreciating our dollar, which is pushing up inflation potentially.

Joey Moloney: Yeah, I think the exchange rate channel is a really interesting one to make, because it’s not really talked about in the discourse at all, but You know, the, the RBA is you know, principal model of the macro economy kind of suggested all else equal.

It’s probably the most powerful channel. So, you know, I take from that, that, you know, you’re talking about the relativities of where Australia’s cash rate compares to comparable economies right now, and we’ve just come off an interest rate pause. My instinct would be that it would be front of mind for the RBA if when they’re considering whether to, you know, keep the cash rate on pause, what our relative position is.

Because if their own model is saying this channel is really powerful, that’s probably something they’re thinking about really carefully.

Trent Wiltshire: One other thing to note as well with monetary policy is that the Reserve Bank uses this monetary policy to, to tinker with aggregate demand. It really has no impact on supply in the short term.

In the long term, it can have a bit of an impact given we want to not have big recessions that cause scarring. Sometimes you hear commentators talk about others. There’s too much is being left to the RBA to generate growth. It’s not really the case. The RBA is focused on linking or limiting aggregate demand or linking aggregate demand to aggregate supply to maintain that stable inflation.

It’s not about driving Productivity you know, increasing the supply side. That’s for other policy makers to do. The RBA cares about, you know, tinkering with demand to keep inflation low and stable. Which is a, as Joey said, a necessary, necessary condition for economic growth, but not a

Kat Clay: Yeah, I find that fascinating.

I didn’t really know anything about the exchange rate being a lever for monetary policy as well. So that’s really interesting to hear that. I think the reason we obviously hear so much about the cash rate and the interest rate rises is because, you know, they do hit that. third of the Australian population and it hits hard.

It’s, it has really hit a lot of households very hard with so many people under mortgage stress and then the flow and impact to the rental market as well. I think I probably know a bit of the answer to this question, but you know, Why are people looking for alternatives to monetary policy? And I think we’d probably go through a few of those alternatives as well.

Joey Moloney: I think it’s a very, a very natural reaction to sort of say there’s a policy decision being made that is distributing pain to certain households. So. It seems very, very like predictable and natural to me that people would be looking around wondering, is there another way to solve this problem? That’s maybe a bit less painful.

So, like you said, I think most people are looking at that cash flow term. Most people, looking at what’s the impact on their mortgage repayments and thinking, this is really, really hurting me. Is there an alternative? There’s also another concern that people have, which is that, you know, by design, like we’ve been saying, the point of higher interest rates is to try to reduce aggregate demand.

If you reduce aggregate demand, you risk higher unemployment. So I think some people are concerned about that kind of broader impact as well. You know, at the outset, it’s really important to be realistic about the fact that there is no real way to get inflation down without imposing costs. It’s really, the question is then about who bears these costs and, and to what degree, you know, like we’ve been talking about.

The fundamentals are an imbalance of aggregate supply and aggregate demand, and like Trent said, you can’t just increase the productive capacity or aggregate supply overnight. We’re always trying to do this. Policymakers, economists, politicians are always trying to make the economy more productive.

There’s been lots of ink spilled you know, over decades on how to improve productivity in the Australian economy, and we’ve been in this productivity slump for a while, and I think that goes to show it’s It’s really hard and it’s a long term project and you can’t do it overnight. We are essentially left with no choice but to try to target our aggregate demand, which of course does risk higher unemployment.

The RBA Deputy Governor, Michelle Bullock. Was pretty upfront about this in a speech last week about risking higher unemployment is a natural and expected consequences, consequence of higher interest rates. How do higher interest rates distribute pain? It broadly in one sense, because of all those different channels we were going through before, they distribute pain sort of here, there and everywhere.

But it is fair to say that it will tend to, it does kind of concentrate itself on households with a lot of mortgage debt. You know, there’s typically younger to middle aged households early in their mortgage, big mortgages because house prices are, you know, through the roof in this country. It’s important to note that these households are typically probably on the higher income side.

You know, not rich, rich, but probably on the higher income side. And on the flip side, lower income households. Typically don’t have mortgages, so aren’t really being, you know, hit by the cash flow channel as hard as other households. And another thing just worth noting is that if inflation is diminishing the value of each dollar, then it’s diminishing the value of each dollar that denominates the outstanding principle on your mortgage.

So it does actually erode the value of debt too.

Kat Clay: Yeah, and I think this is a really interesting aspect of it. I mean, the RBA is using what levers it has, but there are other things out there. And fiscal policy is where governments are using taxing and spending decisions to influence inflation. But I’d really like to know why fiscal policy isn’t the main lever used to control inflation.

Trent Wiltshire: Governments used to, used to play a big role in this sort of day to day tinkering with the economy to try and manage inflation. It was handed over primarily to the. Reserve Bank in the early 90s, early to mid 90s. That followed a trend across the world of central banks becoming more independent and having this responsibility of targeting inflation.

And that’s been the predominant method of managing the demand side or managing the cyclical nature of the economy. Previously, governments did play a much more active role. You look back at, say, World War Two, post World War Two, the government was really active in that fiscal policy space. So it could be done.

But it’s, there are some downsides to it. So now you think about the Commonwealth government, it’s spending is big. It’s about 25 percent of the economy. So it’s taxes, taxing and spending decisions, you know, could really quite easily. Or can and do influence, you know, how the economy tracks. But why is it good that the Reserve Bank has a responsibility of interest rates and fiscal day to day management rather than the government?

Well, simply put, politicians don’t like making unpopular decisions and are very likely to bow to public pressure when things get tough. So, you can imagine earlier this year, you know, Phil Lowe’s very unpopular, he’s raising rates. Inflation’s too high, it needs to come down. As Joe just talked about, you know, there’s tough trade offs here.

Someone ultimately loses from how to get inflation down. If the government, if the treasurer had his, was able to manipulate interest rates, it’s very likely with all the front page stories about how much it’s hurting households. The treasurer would have stopped raising rates earlier this year, and we’d be left with high and lingering inflation.

Instead, the unpopularity gets handed over to, to Dr. Lowe, who you know, is willing to cop it. He’s not up for election in a couple of years time, although he’s being, potentially being reappointed soon. But he’s, he’s independent, so he’s able to Raise rates without the consequences that a politician would face.

Kat Clay: Yeah, I was thinking that you know, if Philip Lowe had been a politician, I mean, there’s been protesters outside of the RBA. I’ve never heard of that before.

Trent Wiltshire: In the late 2000s when the Reserve Bank was raising rates again because inflation was too high, I think Glenn Stevens, the governor at the time, was labeled the most unpopular man or the most hated man in Australia on the front pages.

So, this is not uncommon. A key reason why the Reserve Bank is handed the responsibility of you know, managing inflation. The evidence shows that countries with more independent central banks, they have lower inflation than, than other countries that the central banks are more influenced by government.

Another reason why monetary policy is better than fiscal policy is that Fiscal policy is not as nimble as monetary policy. So if the government’s changing laws, it has to go through parliament. Good policy might get shifted by, you know, horse trading in the Senate and things get shifted around. So we don’t end up with optimal policy to manage demand.

The timeliness, the way it actually gets implemented can be. Not as you know, not optimal. And a good example of that is the home builder episode from 2020 at the time seemed like a great idea to support the construction sector, you know, giving money to households to renovate or build new houses. In the end, it’s been a really poor policy.

It’s actually. Contributed to higher construction costs, which as a result of meant, you know, construction companies have faced these much higher costs they’ve gone under it’s affect a lot of households that slowed the pipeline. So it was good intent, but in the end, barely designed and badly timed.

Kat Clay: What I’m thinking is why don’t we have an independent body like the RBA does for monetary policy for fiscal policy?

Joey Moloney: It’s certainly theoretically possible, and it’s certainly something that is brought up a lot. You know, like Grant was talking about. Independence is a, can be a really desirable feature for macroeconomic management, particularly in an inflationary episode when you have to make unpopular decisions. So it can be a very attractive idea to sort of bureaucrats and, and policy wonks, but it is really worth exploring the considerations about.

inescapably undemocratic in a way. So, you know, independent fiscal policy would remove at least to some degree, two quick key questions from the democratic process. So, you know, first, how much tax is the government collecting? How big is the government going to be? How much of the income generated by the economy is the government going to take?

And then second, how is that tax collected? You know, there’s a whole different way that you can levy taxes in an economy and they all You know, equity or distributional impacts. They impact different people in different ways to different degrees. So, you know, these are really, really important questions for a society to grapple with and, you know, a lot of the great thinkers over the years, like, you know people like Locke and Rousseau wrote a lot about the.

of people having democratic representation and having a say in the imposition of taxes in their society. So it’s not to say that that makes this idea implausible or impossible, but it’s just to say that it has some deep philosophical questions that it needs to grapple with.

Trent Wiltshire: Also with you know, we talk about the reserve bank being independent.

Now, ultimately it is accountable to the people via the parliament. So the senior leadership of the RBA. Appear before the house of reps and the Senate a few times a year, the governor is ultimately appointed by the treasurer who’s you know a member of parliament and subject to the democratic process as well.

So there’s a degree of independence from the RBA, but it’s not fully independent from government. So, you know, this process or the setup we have in terms of monetary policy could change and if the people decide that’s what they want, but you know, these are the pros and cons of the process we have at the moment.

Kat Clay: Yeah, that is so interesting both of you, because I have never really thought about, you know, the ability to have representation to question, you know, the taxes that are imposed on me as a citizen as something really important. You know, we often think of taxes, the thing that’s over there that we do once a year.

But when you think about it and you play it out to its logical conclusion, there’s so many ways that taxes could enforce inequality and could create a very unjust and unfair society. So I think it’s a really important. Point you make here. I think we should play a bit of a fun game though. I mean, let’s imagine a world where fiscal policy was the main lever used to control inflation.

So I want to know what are the options. Maybe you go first, Joey.

Joey Moloney: One option that I’ve heard floated a fair bit is a floating superannuation guarantee rate. So the superannuation guarantee is the compulsory super contributions or the rate of compulsory super contributions that people pay. On their wages.

So, you know, the idea is that that could be that number could float depending on macroeconomic conditions and, and that the decision to move it up or down be given to an independent body. I think it’s sort of, it’s fair to think of the ASHA’s fiscal policy, the ASHA’s in a way. Tantamount to a tax.

It’s just one that produces a one for one vested benefits to the payer and the, you know, It would work because super is just forced savings So, you know the more you clip people’s take home pay the more that you reduce aggregate demand and then vice versa the other way So it would work. There’s probably a couple of issues worth considering when exploring this idea one is It bumps up against something called the Tim Bergen rule.

Now, this is just a general principle that says you probably need as many policy instruments as you have policy objectives. If we try to do two things or more than two things with one policy instrument, we’re probably unlikely to achieve both or achieve even just one or both to a satisfactory degree.

So, you know, the superannuation guarantee or compulsory super contributions are there. For the policy objective of achieving or helping to achieve adequate standards of living in retirement. Now we’re going to say we’re also going to use it for macroeconomic management. Can it do both of those objectives at the same time?

The Tim Bergen rule would say probably not. The second thing worth considering is the equity implications of, you know, using this, using the SG in this fashion. A low income renter, for example, these are typically probably among, you know, The more disadvantaged people in our society are typically poorer people living in the private rental market.

They’re going to suffer more from a higher superannuation guarantee rate. Then a commensurate increase in the cash rate, what my intuition would be, because the higher superannuation guarantee rate is going to clip their take home pay directly, whereas the higher interest rate, they don’t have a mortgage, so it’s not affecting them too much on that front, it’s going to have, you know, like through all the channels we’ve been talking about, it’s going to have an impact, but directly clipping their take home pay by the SG, that’s really something worth considering.

So, you know, if one of the knocks on monetary policy is, it’s a bit blunt, it’s a bit of a blunt tool. I’d argue that using the SG for macroeconomic management could actually be even blunter. It basically, it just hits all wage earners, rich or poor, in equal proportions.

Kat Clay: You just answered the question I was going to ask you, which is, you know, our previous research has shown that superannuation increases come out of wages, and given wages growth is, is Stagnating.

I mean, that sounds like it would actually have a negative flow on effect as you’ve just said. Trent, what other ideas are out there?

Trent Wiltshire: They’re probably similar concepts to the SG one. So, you know, you could potentially have some. System of the GST automatically rising and falling in times of high and low inflations at the moment, high inflation, maybe the GST jumps to 15 percent rather than 10%.

You know, there are lots of difficulties around that though, obviously it’s a, the GST is a deal with the states it’d be very administratively difficult for firms to put this through, but like, you know, it’s, it’s feasible a similar concept might be to, you know, not the GST, you could adjust marginal tax rates instead.

So say that the 40, the 30 percent tax. Bracket sort of jumps to 35 percent in times of high inflation. All these methods are about taking. You know, pay out of people’s pockets to, to you know, withdraw demand out of the economy. So, as we’ve talked about a few times now, this is about different people would feel the, the, the cost of these different policy options.

They’re all sort of taxing options. Another one is on the spending side. So. And the government obviously pays a lot of money in terms of transfer payments, so you can adjust them. So think about the big ones are the pension, the age pension and job seeker. So this is purely a thought experiment, but this is the way that a fiscal policy could work.

So in terms of higher inflation, you’d actually pull back on those payments in terms of high inflation, incredibly politically. Unpopular, basically impossible. And in fact, our system works the other way that these transfer payments are indexed to inflation. So they make sure that they, they maintain their real value in terms of, in terms of high inflation or high wage growth.

So like, again, pure thought experiment that, but that’s how fiscal policy could work in terms of automatically acting as a, a way to adjust aggregate demand. But again, it’s all about who wins and who loses from the different ways of withdrawing stimulus. I can see you’re laughing at that, that suggestion, Kat.

Kat Clay: Trent, I can see the current affair headlines right now, you know, politicians take pensioners money in time of crisis. Exactly. Exactly. I mean, the headlines are endless. I mean, there’s no politician in their right mind that would ever do that.

Trent Wiltshire: So, and another issue, like, with all these options is, you know, we’re talking about times of high inflation, government taking more tax from people.

It’d be really, really, politically hard for the government not to hand back at least some of that in the form of cost of living relief. And you see the government’s really struggling to do that at the moment. Now they’ve done pretty well in terms of holding on to most of the extra tax they’ve collected rather than dishing it out in terms of cost of living relief.

But they have handed it back a little bit of it and that’s a political challenge. Of course there’s another Idea that’s been raised a bit quite recently, and that’s simply price control. So, now it seemed like a really nice, simple idea. Inflation’s too high. Well, why doesn’t the government just step in and say, certain sectors of the economy can’t raise their prices?

Shouldn’t, shouldn’t that just limit inflation and, you know, there’s no issue at all? Well, it probably won’t work overall, but, you know, there’s some pros and cons, so it’s definitely worth discussing. So It’s actually, it actually has happened quite recently. So the government implemented price caps for energy last year.

So in effect, this actually did reduce headline inflation. So there was caps placed on energy prices. The governor of the RBA, Phil Lowe said this shaped off half percentage point of inflation of headline inflation. So that seemed to be effective in terms of reducing inflation. But of course, and Joey said this right at the outset, inflation is about the overall price level.

By capping prices in one area, what simply happened is that, yes, prices came down in that, that particular segment of the, the economy. But people then had more money to spend on other things. So rather than spending your money on heating your home or cooling your home, you could go out for dinner more, you could go on a holiday.

And you see that that’s, that inflation has become very broad based in terms of people. Taking savings and spending on other things. So price controls don’t actually reduce aggregate demand, just changes spending patterns. Noting that, you know, one way that the effect of say price caps on energy might impact inflation is through expectations.

So the fact that headline inflation did come down that might mean that people see that headline inflation is lower than they’ve, than otherwise, that means that future wage demands from people might be a bit lower because the actual true rate of inflation has come down a little bit. So that might feed through to potentially lower interest rates in the future, if it does.

Impact expectations. That’s one way it could work. But in terms of overall distribution and spending, price controls really don’t impact aggregate demand. So Joey, so I’ve talked about price control potentially not working because they Don’t reduce aggregate demand, but what if it’s actually just companies, you know, boosting prices and chasing profits instead, can we do anything to change that?

Joey Moloney: So what you’re alluding to a trend is what’s been broadly dubbed gridflation theory. So this is, from what I gather, the theory sort of suggests that recent increases in prices are Essentially, firms just expanding margins and it’s not necessarily due to any imbalances of aggregate demand and aggregate supply.

So first thing to note is, yes, it’s a correct observation that profits are up. This doesn’t tell you really anything about the causes of underlying inflation. I’m very confident that we’ve had big increase in aggregate demand and we’ve had a Aggregate supply shock as well. And, you know, an increase in demand is almost certain to push up margins, certainly in the short run.

That’s what you’d expect if demand is exceeding supply. There’s a lot of work out there kind of decomposing the contributors to inflation, and that shows you where the money is flowing, but not necessarily what’s causing inflation. So increasing markups or increased profits can be a contributor to inflation without necessarily being a cause of inflation.

So the question is. What’s causing the increased markups. If we just break it down a little bit, you know, price increases can arise three different ways. One, consumers having the means and willingness to pay more, so that’s on the demand side. Two, firms having less to sell or having their costs increase.

Or, the third one is, you know, what economists sometimes refer to as conduct. So this is like firm conduct, how firms map economic conditions to their price setting. And my interpretation of gradeflation theory is that it’s basically saying, We’ve had a change in firm conduct. Well, I haven’t heard a compelling explanation as to why there’d be, why there’s been a big step change in conduct.

But there is some interesting work out there. Professor John Quiggin from the University of Queensland, he’s done some interesting work on how if you have uncompetitive markets to begin with, then you’ll hit with an initial inflationary shock. That inflation can be amplified by the conduct of firms in an already uncompetitive market.

But again, that doesn’t tell you anything about the initial causation of the inflation that still comes back to the fundamentals of aggregate demand and aggregate supply. Australia definitely does have some problems with competitiveness in its economy. Professor Chris Edmond at the University of Melbourne has done a lot of work showing how Australia’s economy is probably less competitive overall than other ones that firms don’t compete as much, particularly in some key industries.

So all of that’s to say, Yeah, we should be trying to do better competition policy all the time. That’s what we have the ACCC for, the Australian Competition and Consumer Commission. They’re working hard day and night to try to make sure we have you know, competitive markets in our economy. It’s just really, really hard.

It can be a really drawn out and legalistic process for the government to try to intervene. To boost competition in markets. And it’s, I think, you know, the upshot for me is it’s competition policy, certainly not a silver bullet for the current moment. Ultimately I come back to the fundamental factors driving aggregate demand and aggregate supply that Trent outlined right at the top.

Kat Clay: Trent, finally, where do you think interest rates are going? Can we have a little bit of economic speculation here?

Trent Wiltshire: At the, the latest board meeting the bank kept rates on hold and they sort of said it was a very finely balanced call. So rates on hold at 4. 1%, 4. 1%. But, you know, in the notes, the The board said some further tightening monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe.

So it’s definitely on the cards that, you know, future, you know, further rate rises may happen. I think we’ll see one to two more, but it’d be really highly dependent on the inflation numbers. So we’ve got the June quarter CPI coming out in late July. That’ll be key. And then also wage outcomes as well. So even though wage outcomes being pretty modest, like they’re ticking up, they’re still pretty modest.

Continually to, to track up and we know that productivity growth is very, you know, you know, negative or sluggish at the moment, those factors combined, I mean, I think the, the RBA will keep raising rates a little bit further before we hit the peak.

Kat Clay: Thank you so much, Trent and Joey. I really appreciated that in depth explainer of inflation because it’s affecting so many of us.

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