The Inflation Elephant in the Room
Written by: Emma Ho
Published: 29th September 2021
Unseen Risks Beneath the Surface
There is no question that the COVID-19 pandemic has caused widespread economic distress – from supply shocks to an unprecedented spike in unemployment, the damages have generally been quite apparent. But is there more than meets the eye?
The Reserve Bank of Australia, in between incrementally lowering the cash rate, has continually denied the prospect of a looming inflation surge. Such inflation is believed to be fueled by global supply shortages and inefficient shipping services. However, the prospect that the June quarter inflation figures will likely overshoot the RBA’s 2-3% annual target is concerning. Rises in inflation have historically been swiftly met with the RBA’s implementation of contractionary monetary policy. These raises in the cash rate have been effective in dispelling such bounds.
The circumstances of this prospective surge, however, are different; inflation pressures are largely being driven by short-term transitory factor, in particular mismatched supply and demand shifts. RBA assistant governor Dr Luci Ellis has sought to allay these fears, citing increasing business production of goods to overcome supply chain bottlenecks as reason for supposedly temporary inflation rises. While this may seem comforting, there is still significant worth in investigating the root causes of such fears.
Volatility in Inflation — Business as Usual?
Firstly, while volatility in inflation is to be generally expected, the unprecedented nature of the current economic climate prompts the question of whether inflationary movements will continue along the same short-term trajectory. This can be observed in the May inflation figures released by the RBA.
Global Demand Meets Fragile Supply Chains
Secondly, and most importantly, strong global demand, largely propelled by global government fiscal stimulus has caused shortages in already disrupted global supply chains. Indeed, international shipping costs have risen sharply alongside shortages in supply of semiconductor chips used in electronic devices and building materials, driven by increased demand for home renovation materials.
According to Dr Ellis, “-it is reasonable to expect that these disruptions will ease over time as bottlenecks are dealt with and health-related constraints on production ease.”
There is already evidence to support these claims.
US lumber prices fell 48% to $US875 per thousand board feet from a peak of $US1686 in early May.
Australia’s inflation rate currently sits at a relatively low 1.1%
A temporary spike in inflation above 3% is expected in the June quarter.
This is largely attributed to the halt of government subsidies — such as 2020’s free childcare services. Further, inflation is forecasted to return below the 2-3% bracket by early 2024, before a sooner-than-expected raise in the cash rate.
The Labour Market Challenge
As of now, the RBA is concerned with the achievement of full employment, which will give rise to greater wage growth above 3% and higher inflation.
The pandemic has seemingly dashed all hopes of such a recovery, resulting in:
A working-age population growth rate of 9,000 individuals per month, compared to 29,000 in 2019
A heartening plummet in the unemployment rate to reach 5.1% which may not be sustainable long term
Our strengthened labour market is largely due to the filling of non-resident job vacancies and skill shortages by Australian residents. This is predicted to turn on its head once international borders are re-opened, and overseas migration rebounds. Increased labour supply will not bode well for the unemployment rate.
Final Thoughts
The RBA’s confidence regarding inflation concerns may well be factually supported. Rather than focusing solely on short-term inflationary movements, the more pressing issue lies in adequately addressing the medium-term surge in labour force and its economic implications.
