Simple way to understand ‘vicious cycle’ in cost of living crisis

Interpreter: Aussies are in the midst of a generational battle inflation – and another rate hike would be proof of how that trickles down.

But does the concept confuse you? Money expert David Koch explains what inflation is and what wages are like Aussies losing their jobs are having an impactand more importantly, how we can keep this under control help alleviate the cost of living crisis.

What is inflation and why can it be bad?

Inflation is the reason a loaf of bread that cost 18 cents in 1962 costs $3 today.

Simply put, it is the increase in prices for goods and services. It happens all the time, but when things go well you barely notice it.

That’s because in an ideal world, wages would also rise steadily to help you afford the cost increases.

The central role of the Reserve Bank of Australia (RBA) is to control inflation, keep our economy healthy and ensure everyday Aussies live comfortably and have jobs.

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To achieve this, the RBA has an inflation target of 2 to 3 percent, which it monitors through the consumer price index. The RBA believes this is the perfect inflation range to support a strong economy.

The problem we have now is that inflation is rising at a rapid pace, and that is difficult to curb. High inflation erodes the purchasing power of every dollar you earn, so if it gets too high it can devastate an economy.

Over the past 18 months, the RBA has used its biggest hammer – interest rates – to slow economic growth and get inflation back under control.

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For a generation, Australians have enjoyed ultra-low interest rates, making the current rate hike cycle a particularly difficult adjustment. It is the sharpest and fastest rise in interest rates since the 1990s.

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A Compare the Market survey of 1,005 mortgage lenders found that 12.5 per cent had used a hardship or payment program to deal with repayments during the 12 months to September 2023.

Inflation is not always our friend, but for people with a mortgage, interest rate increases are often much more painful.

Why do people have to lose their jobs to reduce inflation?

There is no need for people to lose their jobs, but something needs to be done.

The RBA looks at a number of different measures when deciding whether to increase rates, including the impact on employment, wages and spending.

High employment (low unemployment) can be seen as a concern because it means wages are rising as bosses compete for workers. This in turn means that staff have more money to spend, which increases demand for goods and services, which means prices rise, fueling inflation.

It can be quite a vicious circle.

When people are out of work, they usually have no choice but to rein in their spending and focus on the necessities. This reduces demand for goods and services, so suppliers have to lower their prices to attract customers and inflation falls.

But there are other ways to curb inflation without risking people’s jobs and livelihoods.

For example, higher productivity would help increase the supply of in-demand products.

And of course, higher interest rates will help curb consumer spending and reduce their borrowing.

I’m crossing my fingers and toes that we don’t have to sacrifice jobs because that would have a devastating effect on families.

And honestly, governments at all levels can help too and not just leave it to the RBA to do their dirty work and tackle inflation. Governments can cut spending (also called fiscal policy) on goods and services to reduce demand and drive down prices.

Why don’t interest rate increases help with problems such as the housing crisis, the gasoline and energy crisis?

There are many factors affecting prices that the RBA has no control over.

The price of gasoline is influenced by global supply pressures, international conflicts and production guidelines.

Generating and transporting gas and electricity now costs more due to material and infrastructure costs, network poles and wiring costs, environmental costs, and retail and residual costs.

And while some people argue that the RBA should take house prices into account, property affordability is not currently part of its remit. Property prices are about supply and demand, and currently there is not enough supply of new housing to meet our population growth and our large immigration programme.

With building permits currently at their lowest level in a decade, the housing shortage is expected to get much worse before any improvement occurs.

We want wages to go up, right? How does this affect economic problems?

Remember that vicious circle? Workers need higher salaries to cover the rising cost of living, but higher wages mean more spending and higher costs – fueling inflation.

Ultimately, the RBA wants to see less of the kind of discretionary spending that having a higher wage gets us. So it raises interest rates, so we have to spend more on mortgage payments and less on shopping.

The problem is that this means Australians living on a low income are just scraping by.

Their budget considerations are not: “Are we going on a second family vacation this year?” Instead, they are, “Can I afford food for the entire week,” or “Should I skip lunch or breakfast?”

shows that as many as two in five Aussies have cut back on supermarket spending to pay other household bills.

Most alarmingly, 17.7 percent said they had skipped meals.

We must remember that the pressure is not equally distributed. Employers should take this into account when considering salaries next year.

What does migration have to do with inflation?

We often hear about global factors driving inflation. Issues such as labor problems, supply shortages and political unrest all play a role.

But even at home there are a number of factors fueling the inflation fire, such as migration.

Net overseas migration added 454,400 people to the population in the 12 months to March 31 this year.

There is no doubt that we are desperate for a skilled workforce and welcome the financial injection from international students, but it also means that there are another 454,400 people in need of a roof over their heads and food on their plates.

That is 454,400 extra customers for retailers, but it also puts pressure on housing, goods and services.

It should be a serious priority for the government to ensure that we have the infrastructure and housing to support that migration policy.

David Koch is the Economic Director of Compare the Market, leading research and campaigns to help Australians make informed financial decisions.

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