Wednesday, October 22, 2008

What Inflation?

Today’s Consumer Price Index figures show that inflation has now hit 5%. This is what Treasurer Wayne Swan was warning us all about earlier this year when he was talking about the inflation genie getting out of the bottle. At that time it meant interest rates had to go up. Now it’s a different story. Even with inflation rising, all of the talk remains focused on the likelihood of a November interest rate cut of another 0.5% in the battle to head off a recession. So, what’s the story? Isn’t inflation still a problem?

Well, yes it is, because while the cost of living continues to rise people find it harder to make ends meet. But for now the fallout from the Global Financial Crisis is seen as a much bigger problem. Our’s is a consumer economy, and for it to function consumers must continue to buy the things that they need. If they stop doing that, then business revenue falls and jobs will be lost. That becomes a vicious cycle where spending dries up further, leading in turn to more job losses. That’s why it is so important for Government to ensure that the welfare safety net provides at least some spending power to the community.

The expectation is that inflation will reach a peak and then begin to decline as the economic slowdown works its way through the system. In fact, the forecast is that today’s 5% inflation figure is the peak and from here inflation will level out and then fall away. It’s a nice idea, but it’s not guaranteed to work. Perversely, the big money being spent by the Government to prop up the economy could also continue feeding inflation so that the overall effect of the assistance is dissipated. It is a delicate balancing act.

The other problem is that whatever the Government does, and however effective their actions might be, the final outcome is still very much subject to global conditions. The jury is still out on just how badly the Chinese economy might be hit, which will have a direct bearing on just how difficult things become here. Longer term it is reasonable to believe that China will continue to grow strongly, but in the short term there is a chance that a hiccough in the Chinese economy could cause a complete seizure in ours.

In that context, inflation is the least of our worries. But if the theory proves to be wrong, then it could come back to haunt us at a time when we are less well equipped to cope with it. A combination of high inflation and low economic growth is a double whammy that nobody wants, and that’s why cutting off a recession is the priority.

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