As expectations rise for another interest rate hike by year’s end, and the pain of inflation pressure weighs on more households, it’s clear the RBA can’t solve the inflation problem alone. By Mike Seccombe.
Why the cost of living is still too high
Kill the chicken to frighten the monkey, goes the old Chinese proverb; meaning you make an example out of one in order to deter others. This week the Reserve Bank killed its 13th chicken, because the previous 12 had not sufficiently chastened the monkeys.
On Tuesday, after having left the official interest rate unchanged since June, the bank jacked the cash rate another 25 basis points to 4.35 per cent, a 12-year high. In the statement giving reasons for the decision, the RBA governor, Michele Bullock, said inflation was not falling fast enough.
“Inflation in Australia has passed its peak but is still too high and is proving more persistent than expected a few months ago,” she said. “The latest reading on CPI inflation indicates that while goods price inflation has eased further, the prices of many services are continuing to rise briskly.”
And why are those prices going up? Because, in the words of another noted economist, Danielle Wood, some Australians persist in “living large”. Wealthier and older Australians – who are to an ever-increasing extent one and the same – continue to spend up big on all manner of non-essential things.
Meanwhile, other, typically younger, Australians are struggling to afford essentials. They are, in the terms of the proverb, the sacrificial chickens, the ones being hurt the most by rising interest rates, although they are not causing the inflation problem.
Wood, the chief executive of the Grattan Institute, who next week takes up a new role as chair of the Productivity Commission, portrayed the essential unfairness of it in great detail in a speech a couple of months back. The intergenerational lens she applied to the data showed very clearly who was getting squeezed, and who was doing the spending the RBA is trying, not very successfully, to curtail.
Wood cited, for example, data published by the Commonwealth Bank based on credit and debit card transactions from seven million customers, which correlated spending with age.
Between the first quarters of 2022 and 2023, spending by Australians over age 55 increased much faster than the general rate of inflation, while for those under 55 it was well below. Spending by the oldest cohort, the over 75s, grew some 13 per cent, or almost double the inflation rate. Among those aged 25-29, it barely grew at all.
“While the over-55s are ‘living large’, as the kids say – with per capita spending significantly outpacing inflation – younger people’s real consumption has shrunk over the same period. The real declines have been especially pronounced for those aged between 25 and 40,” said Wood.
The number of households experiencing moderate or severe food insecurity rose from 33 per cent in July last year, to 36 per cent, according to the “Foodbank Hunger Report 2023.”
Craig Emerson, economist and former senior minister during the previous Labor government, is harshly critical of the RBA for its decision this week, saying the bank should have used old-fashioned “judgement … not a model or formula”.
“I’d hoped that they would look at the partial indicators, like retail sales for example. That’s a big part of consumer spending. They have hardly increased in nominal terms. In real per capita terms, they have fallen.
“All the indicators show the economy slowing quite sharply.”
The latest inflation data bear this out. Although prices went up 1.2 per cent for the three months to September, the annualised inflation rate continued to track down, from 6 per cent to 5.4. That’s a notable drop from the peak of 7.8 per cent last December.
A small increase in just one quarter might not actually mean all that much, says Cherelle Murphy, EY Oceania’s chief economist.
“It’s not a linear process, and inflation doesn’t necessarily just kind of fall neatly back.”
But she understands the motivation of Bullock and the RBA board.
“Not everything went up in price in the September quarter, but the number of things that did was quite extensive. And there is no clear end to rental inflation.”
Especially given that the reopened borders have brought some 500,000 new people into the country, who will need somewhere to live, she says.
Emerson is particularly bothered by the bank’s preparedness to countenance higher unemployment – Bullock is on record suggesting an increase to 4.5 per cent from the current 3.6 – to dampen demand.
“My argument is, why needlessly throw 140,000 people out of work when inflation is coming down?” he says.
The reality is interest rates are a very imprecise way of fixing a problem that has been a long time in the making.
The picture of intergenerational inequity Danielle Wood painted was not limited to the period since rates started to rise last year. It went to changes in the patterns of wealth and consumption going back several decades. That disruption was then supercharged by the pandemic – from which some people emerged with very large amounts of excess savings – and exacerbated further by the rapid rise in interest rates over the past 18 months.
At the heart of the problem is housing. Back in 1981, Wood noted, when the Baby Boomer generation was settling down and having families, more than two thirds of 30- to 34-year-olds owned their own home. Now it is less than half.
Until the late 1990s, house prices broadly tracked growth in incomes, she said. “But between 1992 and 2018 they grew at almost three times the pace on average.”
Unsurprisingly, as younger cohorts were forced to spend ever more on essentials – particularly housing, whether buying or renting – they had less to spend on other things. Over more than three decades, discretionary spending by younger Australians has declined in real terms.
“Indeed, all households headed by someone under 55 shrank their spending on non-essential goods overall,” said Wood.
Older households also reduced their spending in some discretionary areas – clothing and furnishings, for example – because they became relatively cheaper, but that reduction was “dwarfed” by an increase in spending on recreation, particularly travel.
“Despite the regular handwringing about Millennials choosing smashed avocado brunches over financial responsibility, even before the recent pressures, younger people had increased their spending less than older generations. And all the growth in younger people’s spending was because of spending on essentials,” said Wood.
The cost of those essentials has risen fast, while the capacity of people to pay has not.
“Since December 2021,” she said, “CPI has grown on an annualised basis by 6.7 per cent, including increases of 9 per cent for housing, 8.3 per cent for food and 5.6 per cent for transport – the three biggest items in the CPI basket. Over the same period, base wages have grown by only 3.2 per cent.”
In summary, several factors have combined to make inflation so sticky: a chronic case of increasing inequality, rendered acute by a global pandemic and war. The pandemic disrupted global supply chains, which pushed up the price of goods. Federal government stimulus measures in response to Covid, which injected some half a trillion dollars into the economy, fattened the wallets of business and households, particularly wealthier ones. People working from home decided they needed more space, the average number of people per dwelling decreased, putting pressure on housing supply and pushing up already high real estate prices. The Ukraine war and profiteering by energy companies saw energy prices shoot up. The resulting inflation, which major central banks had initially described as temporary, reached the highest levels in more than a decade in many parts of the world before those banks began to act. The RBA clung to its projection that interest rates wouldn’t rise until 2024 but then, in May 2022, began the most aggressive campaign of rate hikes in a generation.
The good news, says Housing Industry Association chief economist Tim Reardon, is global inflation is rapidly falling.
“What caused inflation to rise was global supply chain shocks. What’s causing inflation to fall is global supply chain improvements,” he says.
The sector in which Reardon works was especially exposed to supply shocks and now is especially exposed to high interest rates. He also believes the RBA has gone too far in hiking them.
“As interest rates go up, we see fewer homes built. Building approvals are at a 10-year low, lending figures are at a 20-year low. That’s a very simple metric, as you make homes more expensive, you get fewer of them,” he says.
Which is a big concern if you are looking to buy a home or have a mortgage. And an even bigger problem if you are among the roughly one third of Australians who rents, which has risen well above the general rate of inflation over the past year or so.
Modelling released in June by the financial comparison site Canstar showed someone wanting to buy a median-priced Sydney house, with a 20 per cent deposit, would require a gross annual income of $255,600 to service the loan.
And as Wood told her audience in August, it would take the average Australian 12 years just to save the deposit, compared with seven years in the 1990s – unless they had help.
She cited a comment by former RBA assistant governor Luci Ellis that the only “realistic” way for many young Australians to enter the housing market was through parents dipping into their savings to assist them.
But there is another way: through inheritance.
“With a swelling of our national household wealth to $14.8 trillion – up more than 190 per cent in real terms since the GFC – most in the hands of older Australians, there is an awfully big pot of wealth to be passed on,” said Wood.
A “birth lottery”, she called it, with a rapidly increasing jackpot. According to Productivity Commission projections, when current retirees die, just 10 per cent of their heirs will receive as much as half the value of bequests.
So, an intergenerational inequity will rapidly become an intragenerational one. Wealthy old parents will make wealthy old children, for most of the heirs won’t see the money until they are in their 50s or 60s.
The irony here is that by increasing rates again this week, the RBA has only exacerbated the gap between young and old, because while higher rates are a problem for those with debt, they are a boon for those with interest-earning assets, who get higher returns on their savings.
“And the beneficiaries of this channel have been overwhelmingly older Australians,” said Wood.
“Richer older households are estimated to have had a cash flow boost of more than $1000 since interest rates started going up.
“And this puts aside the cash savings many older households can access in their super. Up to 16 per cent of all accessible variable-interest assets sit in the super accounts of older, mainly wealthier, Australians who are free to withdraw and spend the extra interest.”
Some have suggested the answer lies not with the bank, but with government. Treasurer Jim Chalmers has already committed to cut back on infrastructure spending, as a review of more than 700 projects across the country found a cost blowout of about $33 billion. Chalmers has promised details of the programs to be axed before the end of the year.
Cherelle Murphy welcomes this focus. “Government – this is something we’ve been banging on about for a while – are spending up big,” she says. “The debt numbers from the state governments are growing very quickly.”
The Albanese government has also made some moves to reduce the cost-of-living pressures on households, such as increasing Medicare benefits and assistance with childcare.
Critics say it is not enough. They suggest increasing the GST, which might impose some restraint on those older and richer people who continue to splash money around. Or reducing demand in the economy by temporarily increasing the super guarantee.
Both are plausible solutions that won’t happen, says Emerson.
“People would say, ‘We’re struggling with the cost of living and you’ve just reduced my take-home pay. Thank you, you can go and get stuffed,’ ” he says.
“I just can’t see that either of those proposals will ever be picked up by the government of either persuasion.”
Emerson says the increasing “generational divide” is becoming a “huge issue” politically – particularly on the issue of affordable housing – which will lead to more young people moving to the Greens.
Meanwhile, it seems the government plans to press ahead with its stage three tax cuts, which will overwhelmingly benefit high-income earners. It must hope the cuts don’t further stimulate demand and force the RBA to sacrifice more chickens.
This article was first published in the print edition of The Saturday Paper on November 11, 2023 as "Why the cost of living is still too high".
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