Inflation’s the battle we have to fight and win

We are fighting a war against inflation and must win. You just have to look at countries where it is out of control to see how destructive it is to the very fabric of society.

It’s often said that generals always fight the last war.

The implication is that they start off doing so, mistakenly, in a new war until they work out new tactics and strategies or, more often, are replaced by new generals who do.

What tends to get lost is why they often have to keep fighting the same enemy.

In my space, economic commentary, that ‘same enemy’ has been inflation.

The one thing that has been locked in policy cement in Australia and indeed pretty much around the world since at least the early 1990s is some sort of commitment to keep inflation around 2 per cent a year.

In Germany (and Switzerland) that commitment goes back into the 1950s, and indeed the 1930s, after Germany’s hyper-inflation of the 1920s that helped spawn Hitler.

And gave a lot of generals a chance in the 1940s to again ‘fight the last war’.

Our neighbour New Zealand was the first country in the world to formally adopt the 2 per cent target, at the end of the 1980s.

It opted for ‘0-2 per cent’, but more recently switched to ‘1-3 per cent, with an emphasis on the 2 per cent mid-point’.

In Australia, we came to our ‘2-3 per cent over the cycle’ by then Reserve Bank governor Bernie Fraser informally adopting it, coming out of the high double digit inflation and the even higher double digit interest rates of the 1980s.

It was then locked, for the first time, in a formal document in 1996 between new treasurer Peter Costello and his newly appointed RBA governor Ian Macfarlane.

And there it’s been ever since.

Federal Treasurer Jim Chalmers. Picture: NCA NewsWire / Dan Peled

New treasurer Jim Chalmers has seemingly, if implicitly, endorsed the target as well - by supporting RBA Governor Philip Lowe’s pleas for wage rises to start with a ‘3 and not the ‘5’ that would match recorded official inflation.

What happens to the target longer term, though, is a very different matter.

It will clearly become pivotal in the promised review of the RBA.

Why is low inflation considered so critical and why 2 per cent?

You don’t have cite the examples of hyper-inflation – Germany in the 1920s, Zimbabwe in the 2000s, Venezuela in the 2010s – to see how crushingly destructive even ‘modest’ double digit inflation is.

Destructive not just across the economy, but to the very fabric of a society.

I would hope that we don’t have to fight that war – of understanding – again.

In the seemingly locked-in double digit inflation of the 1970s across the developed world, including Australia, everything was skewed to people protecting themselves against price rises rather than aimed at productivity, basic, real, economic growth and real rising living standards.

Why the 2 per cent?

Zero or even 1 per cent was seen as too and unnecessarily tough, achievable only by keeping the economy in permanent near recession.

But anything higher, like 3 or 4 per cent, ran the risk of the inflation tiger getting out and really rampaging.

Right now, for the first time since the 1980s, the inflation question is being seriously posed.

Across the OECD it averaged 9.6 per cent on the latest numbers; in the US it hit 8.9 per cent; in Australia it was, past tense, 5.1 per cent through March and will be closer to 7 per cent in the next figures.

Yes, it’s been caused by very unusual drivers – first Covid and more recently Ukraine and, less well understood, the end of the great drivers of falling prices through the 2000s and 2010s.

But the threat remains the same; that it does break into a wages-prices spiral; and the challenge arguably greater; although the primary weapon - interest rates – does not have to be deployed as brutally because the economy is so over-borrowed.