Inflation nation: The cost of Australia's low interest rates
By Dr John Humphreys, Australian Taxpayers’ Alliance Chief Economist
The cost of living in Australia is rising. This theme is becoming central to the election campaign, as a growing number of families are squeezed by the rising price of food, energy, housing, and many other life essentials. Political candidates and media pundits are decrying this trend, but few people want to talk honestly about the underlying cause and vital solutions.
Higher prices are not the product of greedy business people or foreign conflicts; greed and conflict have always existed and do not explain most price changes. It’s simple: Prices are increasing because Australia is facing an inflation problem.
Our central bank has created too much money, which has flooded into the market through artificially low interest rates and record high budget deficits from the government. All this “additional” money does not reflect an equivalent increase in goods and services, meaning the power of a dollar has dwindled. The end result is too much money chasing too few goods, which leads inevitably to higher prices. Milton Friedman explained this succinctly nearly 60 years ago when he noted: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
Inflation is an unpopular topic not only because monetary economics is a niche area, but because the necessary solutions are politically difficult. The solution to artificially low interest rates is higher interest rates just as the solution to an excessive budget deficit is for the government to wind back on spending. Neither are popular with voters, but both are necessary to keep inflation under control.
The political response is more likely to be distraction, denial, and then doubling down on making the problem worse. The government has predictably denied responsibility and is busy promising ever-more spending. The opposition may throw stones about the deteriorating situation, but they don’t offer any meaningful solutions. Some minor parties are even arguing to keep interest rates lower for longer, in a move that will aggravate the situation and lead to ruin in the not-so-distant future.
The danger at this point is that inflation will continue to spiral up while politicians avoid the hard decisions. We have seen this before in the early 1970s when the Australian Government copied the economic trends of the time by creating too much money and running too-high deficits. This “stimulus” was politically popular in the short run, but the result was that inflation spiked to over 15% in 1974 and hovered around 10% for about a decade. After a lost decade of high inflation and low growth, it took some real political leadership in the 1980s and 1990s that managed to balance the budget and stabilise the value of money. Let’s hope it doesn’t take our current political leaders that long before they rediscover the importance of responsible economic management.