The cost of living versus the cost of winning
As the worst economic impacts of the COVID-19 pandemic appear to be waning, the cost of living is coming into focus as the major issue facing Australians, potentially swinging their vote as the election approaches.
But why are we finding it harder to make ends meet? Will things get better soon? And what can the Commonwealth government do to help ease the pressure? Well, as my old State Treasury colleagues would say: it’s complicated and it depends.
Rising cost of living is generally synonymous with higher inflation. But inflation has been fairly stable over the last five years with the Consumer Price Index (CPI) hovering around 0.0% to 0.6%.
There was a short-lived bump of 1.6% in September 2020 but that was just making up for a -1.9% reading in June 2020, the quarter where we weathered the worst of lockdowns and the peak of pandemic restrictions.
But, following recordings of 0.8% in June and September 2021, we experienced a sharp jump to 1.3% in the December 2021 quarter.
Then the March 2022 quarter wasn’t to be outdone and gave us an increase in of 2.1%, the second highest figure since September 2000.
This brought the increase in CPI for the 12 months to the end of March 2022 to a whopping 5.1%, the highest 12 month read since June 2001 (A more innocent time when Shaggy’s “Angel” was top of the charts for eight weeks).
The main contributors to the March quarter figures were education (up 4.5%) and transport (up 4.2%).
Tertiary education rose 6.3% for the quarter while secondary and primary education were up 3.0% and 4.5% respectively.
Unsurprisingly, automotive fuel was the main driver (sorry!) of the transport figures, up 11% for the quarter and 35.1% for the 12 months, while motor vehicle prices were up 6.6% for the 12 months.
For Perth, inflation was 3.3% for the March quarter and a very concerning 7.4% for the 12 months to March 2022.
These figures ranked highest of all capital cities with Melbourne recording the second highest quarterly figure well below Perth at 2.3%.
Brisbane “won” the silver for the 12 monthly figures with 6.0% growth in CPI.
The figures make for uncomfortable, if not eye watering, reading but statistics are useless without context.
Understanding the reasons behind the figures may help to decipher interest rate changes, politicians’ promises and may even influence how you vote on May 21.
Inflation is caused by many factors, but the simplest way to think about it is that prices rise when demand outstrips supply.
The closed border response to the COVID-19 pandemic meant a decrease in supply as many imported goods were not coming into Australia.
Essential items were coming in, but a lot of non-essential items were nigh on impossible to source, and so prices rose.
But don’t just blame McGowan – lock downs or restrictions in the country of origin or manufacture also lead to less supply of imported goods.
If restrictions in Italy mean the Ferrari factory workers can’t go to work, then you won’t be taking delivery of that Ferrari any time soon.
Closer to home, panic buying at the beginning of the pandemic also had an impact on supply as existing stock was stripped from shelves immediately and replacement stock takes time to manufacture, source and transport.
Panic buying also meant that demand was increasing just as supplies were being exhausted.
It could be expected that these impacts will go the other way and demand will dry up while people work through their panic supplies of toilet paper and pasta, offering some relief to inflationary pressures. But this remains to be seen.
In Western Australia there was also the impact of flooding to both the east-west rail and heavy road transport links in South Australia, heavily restricting major overland supply routes in January.
As well as keeping supply down, logistics and transport companies were forced to find alternate (i.e., more expensive) routes to Western Australian markets.
These costs are then at least partially passed on to consumers further feeding the inflation beast.
War in Ukraine
The Russian invasion of Ukraine and associated bans on Russian oil imports by many countries has led to an increase in the global price of oil.
While the global price of oil has come down from its recent peaks of early March, it is still around 65% above the lower prices of late 2021.
And we are still feeling it in the form of high petrol prices – the cost per litre at most Perth petrol stations breached the psychological $2 barrier in March and continued to climb ahead of government intervention.
But the impact goes beyond so called “motorists” (isn’t just about everyone in Perth a motorist?).
More expensive fuel means higher transport costs and higher production costs (especially for farmers) and these costs will be passed on to consumers.
Inflation in the United States (measured by US CPI) was 8.5% for the year to March 2022, a 41‑year record.
In the UK, inflation hit a 30 year high of 6.2% in March and at the same time, European Union inflation come in at 7.4%.
In today’s global economy, this is a big risk to Australia as high inflation overseas can also feed domestic inflation.
If production inputs imported from overseas are more expensive, then the cost of production will rise, and these cost increases will also be passed onto consumers.
The expectation of inflation can also play a role as people read more and more about looming inflation; they act to ensure it happens.
There is currently a lot of media coverage regarding inflationary pressures which may convince retailers, wholesalers or producers to increase prices in anticipation of the inflation to come.
Consumers will also adjust behaviour if they expect inflation, there is no point hoarding your money at 2.25% interest when inflation is 5.1% and rising.
You’re better off running out and buying as much as you can while you still can. This fuels demand which self-fulfills the prophecy by increasing prices.
Vocation compensation inflation
The other side of the cost-of-living equation is wages growth or, in the case our current environment, a lack of it.
If prices go up by 2% but wages also go up by 2%, then no one is any better or worse off. People can afford the same amount and quality of good and services with their new wage level. The cost of living is not an issue, and everyone goes about their happy consumer lives.
Wages are measured by the Wage Price Index (WPI) and in the December 2021 quarter the WPI was up by 0.7%, contributing to a 2.3% rise for the 12 months to December 2021.
This is the fifth highest quarterly reading since December 2012 and the fifth highest quarterly reading over that period.
What is evident from these figures, however, is that WPI is not keeping pace with CPI.
Nationally, there is a significant difference between 3.5% inflation for the goods and services we bought in the December quarter and the 0.7% increase in what we use to pay for it.
It’s worse here in WA – the West recorded the lowest quarterly (0.5%) and annual wages growth (2.0%) of all States and Territories.
Remember Perth’s inflation rate was 7.4% in March? So, what we’re buying is going up by 5.4% more than what we have to buy it with, putting most of us in worse shape than the West Coast Eagles.
Except we can’t even afford to go to the Hip-e Club.
There are several reasons why the economy remains strong and wages growth is low despite rising prices.
National unemployment was 4.2% for the month of December 2021 and has since dropped to 4.0% in February 2022.
This historically low figure means more people are employed which means more people are spending money and keeping the economy moving.
So, while individuals may be balancing their wage/price mismatch, there are more people earning a wage to be able to contribute to GDP.
The Great Resignation
A lot has been said about what is being called “The Great Resignation”, people shifting jobs as a result of the COVID-19 pandemic.
The theory around the great resignation is that people are prioritising benefits such as flexible work arrangements above pay rates when choosing where they work.
If this was the case, there would be downwards pressure on wages, as people leave higher paying jobs for lower paying ones with more attractive other benefits.
Australia’s household saving ratio has risen significantly over the last three years.
After averaging around 6% from 2013 to 2018, it rose to a peak of 19.8% in the June 2020 quarter and sat at 13.6% in December last year.
Intuitively, this seems to be a response to both the uncertainty caused by the COVID‑19 pandemic and the lack of spending during associated lock downs.
What it means practically is that Australia can be expected to weather a certain level of inflation without having to renegotiate wage increases by dipping into savings.
There is obviously only a finite level of savings though and, once this is exhausted, upwards pressure will come on wages.
Given inflation has set in and the opportunity cost of holding savings is becoming greater (see Expected Inflation section) these savings could be exhausted sooner rather than later.
In April, the S&P/ASX 200 stock market index averaged 7470 points, up 6.6% from the same month last year and the second highest average monthly level ever, surpassed only by the historical peak of 7522 points in August 2021.
Private share ownership in Australia is relatively high, meaning price appreciation and high dividend payments offer many Australians strong alternative income sources.
Housing prices and rental returns are also historically high, offering those invested in real estate a similar, if not bigger, windfall.
For most households, housing costs are the single biggest outgoing and one that cannot be substituted or avoided.
While the Reserve Bank of Australia recently raised the cash rate target to 0.35%, it remains very low and before that increase, we have enjoyed 0.1% rates since November 2020.
Home loan rates are currently being offered for around 2.0% by smaller lenders and as low as 2.2% from the big four banks.
The impact this has on demand and economic activity is significant and households spend less on home loan repayments and have more to spend on goods and services.
This means that the recent inflationary pressure and stagnant wages growth can exist without triggering a wage-price spiral.
With the price of money so low, it has been tempting for households to take on more debt to maintain their level of spending.
Whether the recent increase in the cash rate, and expectation of more to come, smothers some of our appetite for debt fuelled spending or not remains to be seen.
Historically, the RBA has used monetary policy (i.e., varying interest rates up and down) to keep inflation in a band of 2-3% on average, over time.
The RBA previously stated that interest rates will not rise from the current rate of 0.1% until 2023 at the earliest.
However, the folly of making bold predictions such as this was highlighted as the RBA hiked rates up to 0.35% earlier this month.
With inflation now well above the target band, it was a necessary move.
Interest rates will have a significant effect on household demand and could be the catalyst for wage growth leading to a damaging wage-price spiral.
Further rate increases are expected and, if inflation continues the trend of the last two quarters, will be necessary.
Adjusting interest rates, known as monetary policy, is a dangerous balancing act.
Increasing them too much could hit governments, investors, and households too hard and send the economy into a sharp reversal.
Even prior to the pandemic, Australian Government debt was skyrocketing. And of course, the pandemic sent it spiralling even higher.
High interest rates mean higher cost to service this debt. There is also a risk of severe financial stress for over stretched private borrowers should rates go up too much, too quickly or both.
Anecdotally instances of “shrinkflation” are becoming more prevalent as inflation rises. “Shrinkflation” is the practice of selling less product for the same price.
A delicious packet of BBQ chips, for example, previously came in 100-gram packets, but now 90 grams is standard.
This could be seen as a win-win for the waistline and the hip-pocket (in absolute terms) but consumers’ value for money is deteriorating.
Shrinkflation means consumers will be unlikely to adjust their spending patterns as they potentially will not notice the change in volume and the fact they are getting less for the same cost.
This in turn helps producers protect their margins and maintain market share and sales volumes.
It will also help dampen the effects of inflation as economic activity will continue and workers will not seek wage increases.
Inflation is increasing and thus far has not coincided with a proportionate increase in wages.
There are also reasons why this has not manifested in negative impacts to the economy yet.
But with inflation continuing to rise and buffers such as savings and interest rates expected to wane, the below impacts can be expected to be felt soon.
The practice of simply substituting one product for a cheaper one when it becomes too expensive.
While this may seem an innocent practice and a zero-sum game, there could be a far-reaching impact to the economy.
Australian-produced products being substituted for cheaper imported ones can cause domestic business closures and job losses.
It could result in substituting fresh goods for processed or canned goods leading to a downturn in local food production.
Substitution can also lead to non-economic, longer-term impacts such as: substituting private education for public, putting a strain on government funds and education infrastructure, and arguably impacting education outcomes; or adverse health effects stemming from substitution of fresh food with processed food.
Severe inflation can result in avoidance of spending, especially with our most venerable citizens whose pensions and government benefits take longer to adjust to a high price environment.
Anecdotally there are stories currently circulating from support organisations about pensioners choosing between food and power.
There are also stories of some people passing up casual employment due to the cost of the fuel it takes to attend work.
The impacts of avoidant spending behaviours such as these are obvious and can have serious long term economic and health impacts.
One of the biggest risks in an inflationary environment is a wage-price spiral where people demand higher wages to keep pace with inflation causing inflation to increase to keep pace with wages and so it goes until both wages and prices are out of control.
But this has not happened yet, and the economy continues to tick over and at a decent rate – GDP for the December 2021 quarter was 3.4%, the equal highest for 2021 and the highest since 2014.
Investment in unproductive assets
When inflation is high and interest rates are low there is little point in households or businesses saving money as that money gets less valuable as time goes on.
This causes money to move to low-risk investments with a better yield than cash. Most commonly these investments focus on material asset classes like real estate or gold.
This takes investment funds away from business investment and other productive asset classes which can restrict growth in the long term.
Election fixation on inflation
We have shown that the cost of living is going up – in simple terms, the stuff we buy costs more, but we are getting paid the same.
This is a big issue for so called “everyday Australians” and, with an election coming in under two weeks, both parties have acknowledged the problem and are doing their best to help.
Given the timing of the election and the onset of inflation we find ourselves in a strange situation where the RBA is doing what it can to cool the economy and stem consumption, while politicians are showering voters with money and policies aimed at helping them spend more.
The Federal Budget, handed down at the end of March, included a temporary halving (minus 22.1 cents per litre) of the fuel excise.
This helped us all at the retail pumps in April, but the impact has now faded as Perth petrol is about to hit $2 per litre again.
The Labor Party announced a plan to get more first homeowners into their own homes by the government taking a shared equity position.
Our country’s obsession with home ownership has arguably made housing the most distorted market in the nation as both parties have traditionally sought to prop it up and protect the “Great Australian Dream”.
Following the current Government’s Home Builder distortion, Labor’s shared equity policy could create further housing market distortion, having an unintended effect of increasing house prices, and adding to inflation.
As well as cutting the fuel excise, the Liberal Party has pledged to help with cost-of-living pressures by extending more concessions to around 900,000 pensioners.
The result of this policy is pensioners having up to $1,300 a year extra to go out and spend on goods and services.
The debate around what is fair payment for pensioners is one for another day.
But this election promise was framed in the context of alleviating cost of living pressures and what have we learned about increasing incomes? It creates more demand and therefore adds to inflationary pressures.
This week, Anthony Albanese said his party would support a minimum wage rise of at least 5.1% to keep up with inflation.
Like the debate on what is a fair income for pensioners, the question of a fair minimum wage is one for another day but increasing incomes could potentially add to inflationary pressures if this money goes to increased consumption (i.e., demand goes up, so prices do accordingly).
Prime Minister Scott Morrison went out of his way to point this out after Mr Albanese’s comments, all the while forgetting his own increase to pensioners’ incomes.
Although $1,300 a year for pensioners and a bump in the minimum wage may not be enough to have a significant impact on the bottom-line inflation, it could have knock on effects.
If the more skilled (and higher paid) workforce sees these increases and seek their own, then we could move into wage-price spiral territory.
Is there actually anything the Federal Government can do to help with rising cost of living? Inflationary pressure from COVID-19, flooding and the war in Ukraine impacts are largely out of their control.
If Scott Morrison doesn’t hold a hose, he certainly won’t drive a tank through downtown Kyiv.
Although policies aimed at supply chain resilience might help shield us from any future disruptions. Imported inflation is mostly unavoidable so there’s not much Government can do there.
Can they help with the wages part of the equation then? Perhaps they can and both leaders seem to think they can, with pensioners and minimum wage earners at least.
However, this will need to be a balancing act to avoid the wage-price spiral. I think we can all support policies to help alleviate cost of living pressures for those who need it most, but the balance has to be right.
In the lead up to the election, both parties are focused on cost of living. The hard part for voters is determining which party is best placed to navigate the issue, and the other unique economic and social challenges of 2022 and beyond.
Government policy can be confusing, and the impacts can be far reaching.
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