Tinteán

by Brian Deane

Ireland and Australia face a number of similar economic and political issues, and among them, currently, is the problem of high inflation. Both countries have been exposed to a broadly parallel inflationary experience, with several years of benign growth followed by a rapid increase following Covid 19, and the war in Ukraine. There is now some hope that the worst is abating, although there is still a long way to go.

In Ireland, The Central Statistics Office (CSO) reported that ‘The Consumer Price Index (CPI) rose by 7.2% between April 2022 and April 2023, down from an annual increase of 7.7% in the 12 months to March 2023.’ ‘The most significant increases in the year were seen in Housing, Water, Electricity, Gas & Other Fuels which was up 20.7% and Food & Non-Alcoholic Beverages, which rose by 13.1%.’

The Australian Bureau of Statistics (ABS) in their most recent report said that ‘Annually, the CPI rose 7.0 per cent, with new dwellings (+12.7 per cent), domestic holiday travel and accommodation (+25.0 per cent) and electricity (+15.5 per cent) the most significant contributors.’ ‘Annual inflation for goods of 7.6 per cent was down from the 9.5 per cent recorded in December.’

The question therefore of how Australia and Ireland go about addressing the challenge that inflation poses is highly pertinent. It is also the case that there is a degree of misinformation in some of the commentary.

In Australia, the main policy tool for controlling inflation is the preserve of the Reserve Bank.

The Reserve Bank Board, as determined by the Reserve Bank Act 1959, has three objectives when setting monetary policy. The three objectives are:

• The stability of the currency of Australia 
• The maintenance of full employment in Australia 
• The economic prosperity and welfare of the people of Australia.

In Ireland ‘The Central Bank contributes to an Eurosystem monetary policy which aims to ensure price stability. Our Governor is a member of the Governing Council of the European Central Bank (ECB), which meets every six weeks to review monetary policy. We are responsible for implementing policy decisions in Ireland as part of this decentralised structure.’

Since the advent of the Euro the ECB cooperates with all members in determining how to control inflation. ‘The ECB’s Governing Council, after concluding its strategy review in July 2021, considers that price stability is best maintained by aiming for 2% inflation over the medium term.’

This target of attaining a rate of inflation of between 2% and 3% is common to all central banks, whether it is the Australian Reserve Bank, the U. S. Federal Reserve Bank, the European Central Bank, or any other.

The question of why a rate of 2% to 3% should be considered desirable is because it allows central banks to balance the competing goals of price stability and economic growth. In a wider economic sense, it is thought that a moderate level of inflation is desirable because when people think that prices will rise in the future, they tend to make purchases sooner, which increases economic activity. Inflation can also make borrowing more attractive because the value of money decreases over time.

It is best to start with a clear understanding of what inflation is. The Reserve Bank of Australia defines inflation as follows:

‘An increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices.’

Inflation is seen as important because it can result in decreased standards of living for those who rely on fixed incomes or savings; it depresses economic growth and adversely effects competitiveness in international markets.

Before a government can tackle the issue of inflation it should of course, at the outset, identify what is giving rise to the increase in prices, and thus make sure that policy responses are directed to counter that problem. This applies to both the Australian and Irish government, or for that matter, any other. The increases can emanate from a number of different sources the more important of which are:

• An increase in the supply of money in an economy which can result in what is known as demand-pull inflation. This is the case when the people in a country have more money than there are goods available to satisfy their needs, a case of too much money chasing too few goods. In this case the consumption of goods and services outruns the supply of those goods and services and results in upward price pressures.
• Price pressures which can also result from an increase in the cost of production, which is called cost-push inflation. In this case any of those elements that impact on the cost of providing a good or services: such as labour, raw materials or meals in restaurants may have increased.
• A sudden increase in the cost of some essential import, as for example petrol, which can have a dramatic impact.
• A decrease in the value of the Australian dollar, for example, relative to the value of currency in those countries from which we import raw materials and goods for consumption purposes, which will bring about higher prices here.
• Supply chain issues that have led to shortages in the supply of items for which there are no ready domestically produced substitutes in Australia will which cause prices to rise.

Any government seeking to address inflation has two main policy alternatives it can turn to:

1. One is monetary policy which is described by the Australian Reserve Bank in the following terms. ‘In Australia, monetary policy involves influencing interest rates to affect aggregate demand, employment and inflation in the economy. It is one of the main economic policies used to stabilise business cycles. The Reserve Bank is responsible for monetary policy in Australia, and it sets a target for the nation’s official interest rate, which is referred to as the ‘cash rate’. The cash rate is the conventional tool of monetary policy in Australia. Monetary policy has a strong influence over interest rates in the economy, including the lending and deposit rates faced by households and businesses. In turn, these interest rates influence economic activity, employment, and inflation.’

• The other is fiscal policy which involves taxation and expenditure on the part of the public sector to influence the level of demand in the economy with the goal of increasing employment without increasing the level of inflation.

Monetary policy is based on the idea that a change in the base rate of interest will flow through the economy to have the following effects:

• An increase in interest rates will depress economic activity, which results in less demand for labour and pushes people into unemployment. Lower interest rates have the opposite effect and stimulate economic growth, and with it an increased demand for labour.
• It affects the borrowing and spending behaviour of households and businesses.
• It influences the demand for goods and services, which can impact on the level of inflation.
• It has an impact on the level of investment through affecting the availability of credit.
• It can also influence exchange rates by affecting the demand for a currency.

The Australian Reserve Bank has increased the bank rate eleven times in the past year. But what is it that they are really trying to do by these increases? What is their ultimate goal? When interest rates go up it increases the cost of borrowing that individuals must pay for goods and services: for example, a mortgage is now more expensive, the car about to be purchased will now cost more and so on. This results in people having less money to spend on other goods and services, and the individuals who would have been employed to provide those goods and services are now no longer required and are let go. It also makes investment on the part of businesses more expensive, so they do not buy the machine they were going to purchase, and the people who make and sell that machine are also let go.

In a recent interview on ABC Radio a past director of the Reserve Bank put it plainly when he said that until there was a strong increase in unemployment inflation would not moderate. This comment highlights the long-held view that there is a relationship between the level of employment and inflation, a relationship that is summarised by the acronym NAIRU, which stands for the Non-accelerating Inflation Rate of Unemployment. The Reserve Bank defines NAIRU as ‘the lowest unemployment rate that can be sustained without causing wages growth and inflation to rise’.  So, understanding what this means is important. It is stating that the number of people employed in the economy must be adjusted in order to attain the target rate of inflation. Professor Kelton, in her recent book Deficit Myth described it in this way, ‘It assumes that the Federal Reserve has the ability to move the economy to its sweet spot, where just the “right” number of people are kept on the sidelines, wanting to work but trapped in unemployment for the sake of keeping prices in check. To put it crudely, the Fed uses unemployed human beings as its primary weapon against inflation’.

There is no precise way of directly determining NAIRU. It is inferred from a range of data, and hence the resulting rate of interest is necessarily speculative, as is evident from the level of disagreement among economists prior to Reserve Bank board meetings. However, the rate chosen has a profound affect on the number of people who have jobs and on those who will lose their jobs.

Fiscal policy, which is the alternative policy to monetary policy, is a proven way for governments to influence economic growth, employment, and prices in the economy. The central mechanism of fiscal policy is that it places the emphasis on taxation and public expenditure. Through this approach it is used to increase economic activity by reducing taxes and increasing government expenditure. Fiscal policy can also be used to reduce demand in the economy by increasing taxes or reducing government spending.

Fiscal policy was at one time the accepted way governments tackled inflation, but it went out of favour in the 1970’s when Milton Friedman led the charge into monetarism. Monetary policy was then espoused by Reagan and Thatcher who made it part of their crusade to radically downsize the public sector and support reduced taxation.

Other than the two main policies there are other ways in which inflation can be addressed:

Central banks can adjust the exchange rate – When our currency increases in value relative to that of other currencies, imports become cheaper. This has the effect of making the imports of raw materials and goods for domestic consumption less expensive. It is thought that this leads to a degree of increased competitiveness among domestic providers as they are forced to compete for market share with the overall impact of a fall in price. At the same time, it makes those items produced in Australia less expensive in those countries which import from Australia. When our currency decreases in value relative to that of other countries then the converse of the above takes place.

Supply-side policies – Supply-side policies aim to increase the productive capacity of the economy and reduce costs. This could involve reducing regulations, improving infrastructure, or investing in education and training to increase productivity. By increasing the supply of goods and services, supply-side policies can help reduce inflationary pressures.

Price controls – can be used to regulate the prices of goods or services in an economy.

However, price controls have generally not been very successful in the fight against inflation as they can result in shortage or surpluses of goods and services.

Wage and price agreements – Wage and price agreements are voluntary agreements between unions and businesses to limit wage increases and price hikes. These agreements can help stabilise prices and wages and reduce inflationary pressures.

At the end of the day, an effective and common-sense way to address the problem of controlling inflation is to use both fiscal and monetary policy. As Professor John Quiggin wrote in a recent article in the Guardian newspaper: ‘We need to abandon the idea of an all-wise central bank keeping spendthrift governments in check. Monetary and fiscal policy should work together as happened during the GFC and pandemic emergencies and as was the norm before the shift to strong forms of central bank independence in the 1990s.’ That is sound advice, and it applies equally to meeting the economic challenge of inflation, whether it is in Ireland or Australia.

Brian Deane was formerly a General Manager, later Head of Strategic Management of Bord Fáilte . He left Bord Fáilte in 1995 to become an independent consultant, specialising in development planning and economic impact studies. As consultant, he worked for the World Bank, African Development Bank, European Commission and others in Africa, the Caribbean, ASEAN countries and Europe, before retiring in 2005. He now lives in Sydney with his daughter Róisín and her family.