Join the dots,and you realise the RBA’s plan to get inflation down quickly involves allowing a transfer of many billions from the pockets of households to the profits of big business.
On one hand,big business has been allowed to raise its prices by more than needed to cover the jump in its costs arising from the supply disruptions of the pandemic and the Ukraine war. On the other,the loss of union bargaining power means big business has had little trouble ensuring its wage bill rises at a much lower rate than retail prices have.
So,it’s households that are picking up the tab for the RBA’s solution to the inflation problem. They’ll pay for it with higher mortgage interest rates and rents,and a fall in the value of their homes,but mainly by having their wages rise by a lot less than the rise in their cost of living.
The RBA’s unspoken game plan is to squeeze households until demand for goods and services has weakened to the point where big business decides that raising its prices to increase its profits would cost it so many sales that it would be left worse off.
It may even come to pass that households have been squeezed so badly big businesses’ sales start falling,and some of them decide that cutting their price to win back sales would leave them better off.
In economists’ notation,maximising profits – or minimising losses – is all about finding the best combination of “p” (price) and “q” (quantity demanded).
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You don’t believe big businesses ever cut their prices? It’s common for them to “discount” their prices in ways that disguise their retreat,using special offers,holding sales,and otherwise allowing a gap between their advertised price and the price many customers actually pay.
But why would that nice mother’s boy Dr Philip Lowe,whose statutory duty is to ensure that monetary policy is directed to “the greatest advantage of the people of Australia”,impose so much pain on so many ordinary people,who played no part in causing the problem he’s grappling with?
Because,as all central bankers do,he sees keeping inflation low as his central responsibility. And he doesn’t see any other way to stop prices rising so rapidly. It’s a case study in just what a crude,inadequate and blunt instrument monetary policy is.
Lowe justifies his measures to reduce inflation quickly by saying this will avoid a recession. But let’s not kid ourselves. This massive transfer of income from households to business profits will deal a great blow to the economy.
After going nowhere much for almost a decade,real household disposable income is now expected to fall for two years in a row. And who knows if there’ll be a third.
Economists have made much of the extra saving households did during the pandemic. But during Lowe’s appearance before the parliamentary economics committee on Friday,it was revealed that about 80 per cent of that extra $270 billion in saving was done by the 40 per cent of households with the highest incomes. So,how much of it ends up being spent is open to question.
The likelihood that our measures to weaken household spending will lead to a recession must be very high.
Until Lowe’s remarks before the committee on Friday,his commentary on the causes and cure of inflation seemed terribly one-sided. The key to reducing inflation was ensuring wages didn’t rise by as much as prices had,so that rising inflation expectations wouldn’t lead to a wage-price spiral.
He warned that the higher wages rose,the higher he’d have to raise interest rates. He lectured the unions,saying they needed to be “flexible” in their wage demands. You could see this as giving an official blessing to businesses resisting union pressure and granting pay rises far lower than prices had risen.
After going nowhere much for almost a decade,real household disposable income is now expected to fall for two years in a row. And who knows if there’ll be a third.
Lowe could just as easily have lectured business to be “flexible” in passing on all the higher cost of their imported inputs,when these were expected to be temporary – but he didn’t. He’s always quoting what business people are saying to him,but never what union leaders say – perhaps because he never talks to them.
But on Friday he evened up the record. “It is also important to note that,to date,the stronger growth in wages has not been a major factor driving inflation higher,” he said. “Businesses,too,have a role in avoiding these damaging outcomes,by not using the higher inflation as cover for an increase in profit margins.”
That’s his first-ever admission that,when conditions allow,business has the market power to raise its prices by more than just its rising costs. Problem is,monetary policy’s only solution to this structural weakness – caused by inadequate competitive pressure – is to keep demand perpetually weak.
Ross Gittins is the economics editor.
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