Cost of living

Lessons learned during the economic tumult of the 1970s could stand Australia and New Zealand in good stead to avoid a recession this time round.

Why are we fuelling inflation?

STRATEGY: BIG IDEAS

For the last quarter of a century there’s been a view held by some economists and many politicians that inflation is dead.

Christopher Niesche is a business journalist and content writer with over two decades experience reporting on topics such as finance, trade, fintech, management, accounting, small business and human resources.

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“Raising rates [in Australia] won’t do much to improve the supply of petrol or electricity, or bring down lettuce prices.”

Sholto Macpherson is an award-winning journalist and editor of DigitalFirst.com, a blog on the latest in accounting technology for accounting firms and SMEs

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– Shane Oliver, AMP Capital

However, any of us who have been grocery shopping, booked a flight or filled the car with petrol in the past few months knows that inflation is very much alive.

Even so, we’re unlikely to return to the surging inflation of the 1970s oil price shocks – that saw inflation soar in Australia from 3.4% in 1972 to 12.3% in 1974 and New Zealand rise from 6.9% to 11.1% in the same period – in part because of the lessons central banks learned from that experience, says Shane Oliver, chief economist at AMP Capital.

Australia

New Zealand

1972

1974

3.4%

12.3%

6.9%

11.1%

Inflation of the 1970s oil price shocks

“They've got the 1970s experience to go by, which is the main difference. And they are more aware of the importance of inflation expectations and the need to make sure they don’t move up with inflation,” he says.

That’s why, for instance, there’s such a strong focus by the US Federal Reserve on the University of Michigan survey of where consumers expect inflation to be in five- and 10-years’ time.

The issue with inflation expectations is that when consumers and businesses expect prices to rise, they put their own prices up, which further fuels inflation. “If people started thinking that's going to continue for the next 10 years, then they get out there and demand high wages to cover that,” Oliver says.

Likewise, people become more accepting of higher inflation, so instead of shopping around for a better deal, they just pay the higher prices. And companies build cost rises of, say, 5% or 6% into their financial models.

Central banks have responded with rapid and unprecedented series of large rate rises. The Reserve Bank of Australia has, this year, lifted the official cash rate from the pandemic emergency low of 0.1% to 2.85%. While the Reserve Bank of New Zealand has raised rates from 0.75% to 3.5%.

Australia

New Zealand

Pandemic emergency low

2022

0.75%

3.5%

0.1%

Cash rates in Australia and New Zealand

2.85%

“They probably learned from the ’70s that rather than sit on their hands and say it’s transitory… they've got to move quickly,” Oliver says. “Therefore they know they have to sound really tough. They have to sound committed, resolute, all these words they keep wheeling out. They have to have said all that to send a signal to the community, businesses or consumers that they're not going to tolerate a return to high inflation.”

Central banks are copping a lot of flak for the rate rises, with some commentators saying they risk pushing their economies into recession, but Oliver says they consider the alternative of not being tough enough to be worse.

“If you get locked in inflation at 8% or 9%, then we get a rerun of the 1970s, which was a horrible period in terms of economic outcomes,” he says.

Inflation is currently running at about 7.3% in Australia and 7.2% in New Zealand, while in the US it’s at about 8%.

Australia

New Zealand

7.3%

7.2%

Currrent inflation rates

Initially it started as supply-side inflation, with the COVID-19 pandemic disrupting supply chains. It didn’t show up during the first year of the pandemic, but became evident in the second after companies had exhausted their inventories, Oliver says. Since then, the war in Ukraine has pushed up commodity prices, further fuelling inflation.

Inflation has now broadened out to a demand problem as well, with demand running over and above the economy’s capacity to produce.

All up, it makes for a difficult situation for central banks to navigate.

“Raising rates [in Australia] won’t do much to improve the supply of petrol or electricity, or bring down lettuce prices which were inflated by shortages caused by the floods. And then you end up just killing demand and you end up with greater risk of recession,” Oliver says.

For the last quarter of a century there’s been a view held by some economists and many politicians that inflation is dead.

However, any of us who have been grocery shopping, booked a flight or filled the car with petrol in the past few months knows that inflation is very much alive.

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