Low inflation numbers call for strong growth measures

Subdued consumer price index figures released on Wednesday confirm the instincts of the Reserve Bank of Australia to maintain ultra-low interest rates for years into the future. This in turn provides flexibility and some challenges for Josh Frydenberg as he finalises the May 11 federal budget. The low rates, lack of inflationary pressures and absence of wages growth puts the onus on government and fiscal policy to grow the economy. In a speech on Thursday, the Treasurer will argue that now is not the time for austerity. He will say given the historic low interest rate environment, the best strategy is to boost growth to shrink the ratio of debt to GDP and bring the budget back into shape over time. Private sector growth is the essential ingredient. Deep cuts to unemployment and rising wages are needed to restore the economy to full health.

The size of the challenge is reflected in Wednesday’s CPI figures. They defied private sector expectations of a bounce back in inflation, which fell to 0.6 per cent over the first three months of the year, taking the annual rise in CPI to 1.1 per cent from 0.9 per cent the previous year. The rise is well short of the RBA target range of 2-3 per cent and a long way short of what is required to put any upward pressure on wages. In headline terms, the most significant price rise was automotive fuel, which jumped 8.7 per cent, and the most significant price fall was furniture, down 3 per cent.

The challenge with the latest CPI data is to strip out the pandemic distortions. These include constraints on consumer behaviour because of lockdowns, as well as the impact of government stimulus programs. Private sector economists had expected the March quarter CPI figures to be more robust, perhaps signalling a return of inflationary pressures that would put a question mark over the RBA’s interest rates approach. The CPI rose in all capital cities but was most pronounced in Perth, at 1.4 per cent, and Darwin, at 2.6 per cent. Perth’s rise includes a 41.6 per cent jump in electricity costs as a state government subsidy was exhausted. But strong economic conditions in Western Australia have also been reflected in national employment growth, which pushed the jobless rate down to 5.6 per cent in March. WA accounted for nearly half the total lift in employment that month.

The WA economy is being supercharged by booming iron ore prices, which continue to set records. And record income from iron ore exports is also boosting national income, giving Mr Frydenberg more flexibility in framing the budget.

In its most recent minutes, the RBA said while annual CPI inflation was expected to rise temporarily to about 3 per cent around the middle of the year as a result of the reversal of some pandemic-related price reductions, in underlying terms inflation was expected to remain below 2 per cent over both 2021 and 2022. For interest rates to rise, the RBA says wages growth will need to be sustainably above 3 per cent, which is well above its current level.

Both the RBA and Treasury now estimate the unemployment rate will need to have a four in front of it for inflation and wages to accelerate. Mr Frydenberg says that unlike in earlier periods of crisis, the RBA has reduced scope to cut rates to drive unemployment lower and wages higher. This has placed more of the burden on fiscal policy. In short, the government must look to other measures to get things moving. Bringing forward the third stage of tax cuts for high and middle-income earners as recommended by business groups would be a good place to start.