Death of inflation buries wages increases
Australia’s inflation rate dropped to an underlying 1.2% year-ended September, effectively killing off inflation, and with it, any prospect of wages growth in the near term. Of course, the recession has played a large part in seeing real prices grow in only the most meagre of ways, but of course, the trend was headed down anyway.
Although the headline inflation rate was 0.7%, the Reserve Bank’s 27 year venerable target is for underlying inflation to be between 2% and 3% per annum, so we rely on that more stable and less volatile measure. For more than half a decade inflation has been incapable of averaging even the bottom of the target range.
In more than just a headline grabbing manner, and certainly more than just immediately, the fact is that inflation is near dead. And that has serious implications.
As we examine the inflation chart below, it is important to keep in mind that Australia’s experience is not radically different to that of most developed economies.
As Ross Gittins discussed in The Age at the end of October, like most developed economies, Australia’s period of consistent and quite high inflation growth ended around 1990. Notwithstanding the burst of inflation prior to the GFC, for most of the last thirty years, the trend has been down, and for all of the last decade, the chart shows us that is the case.
At the very end of the chart, shown in the blue bars, we can see that inflation went negative in the June quarter (-0.3%) and recovered to 0.7% in the September quarter. But that is a story of immediacy, coloured by the one-off lockdowns, payments and so on of this strangest of strange years.
Real prices growth has effectively been falling for at least a decade and has reached pretty much the rock-bottom level, despite the historically low interest rates. Expectations are now that in managing monetary policy, the Reserve Bank, for example, will focus less on the target and more on the actual inflation rate.
That is, if the inflation rate is below the target NOW, the RBA will act to help it move up, regardless of what it thinks might happen in three or four quarters time. The inflation rate is on the ‘active watch list’ in the hospital for failing economic measures.
The long period over which the inflation rate rose in Australia (as elsewhere) was characterised by a period in which expectations created inflation. The heady mix of expectations included businesses passing on increased costs, knowing their customers would do the same and consumers, faced with increased prices, expecting and receiving higher wages increases to compensate. We can argue the chicken and the egg on that cycle, but it doesn’t really matter where it starts.
What matters is when it ended.
Sometime in the midst of the economic transformation of the late 1980s and early 1990s, the balance of expectations shifted, throughout the economy. First, it moved slowly, and then it picked up pace.
Gittins reports the former Reserve Bank Governor Ian Macfarlane as saying (on a podcast – there’s another thing that has changed!) the major reason for the shift in expectations and outcomes was:
“…that, in the long struggle between capital and labour, the interests of capital took precedence over those of labour.”
Some will gag at the thought, from an ideological perspective, but as Gittins went on to explain:
“…the bargaining power of labour collapsed. In most countries the labour share of gross domestic product has declined, with the profits share increasing. Wage growth has been restrained, … and the inequality of income and wealth has increased.”
That is probably a little too shorthand for the full impact of what have been more complex, nuanced and gradual developments, but the idea is clear and broadly, compelling.
What has definitely occurred over the last couple of decades at least is globalisation has pushed prices down, especially linked to lower-cost manufacturing countries like China. That in turn placed businesses in developed countries under pressure, the responses to which included wages restraint, labour-saving capita introductions and other measures to compete.
Ultimately, that heady combination has killed off inflation, and with it, any real prospect of wages growth in the next few years at least.
What that means for the Australian economy is, at the moment, more than a little difficult to understand.