The Reserve Bank governor has warned that life will continue to be difficult for policymakers – which likely means most households and businesses too.
Core items:
- RBA Governor Philip Lowe says globalization has helped central banks keep inflation low and stable over the past three decades
- Increasing trade restrictions and global conflicts reverse this process, risking reduced supply and higher prices
- Mr Lowe says the effects of climate change are also likely to push up prices and make them more volatile
After almost three decades of low and stable inflation, which has generally stayed within the Reserve Bank’s target range of 2% to 3%, central bankers have been surprised by the rise in inflation over the past year and a half.
“An inflation rate of 7 or 8 per cent was something that was widely believed to have gone down in the history books,” RBA Governor Philip Lowe said at Australia’s annual Economic Development Committee dinner.
“That’s why the current hyperinflation is quite a shock.”
Mr Lowe again warned that it was important to rein in inflation quickly before expectations of higher prices set in, as doing otherwise would be much more difficult and economically damaging than it was in the 1980s and early 1990s.
“Reducing inflation required high interest rates and was associated with a deep recession and a rise in the unemployment rate of at least 5 percentage points,” he noted.
“The high unemployment continued for years, leaving deep scars on the job market and damaging our communities. It was very costly.”
So far, Mr Lowe is confident that inflation expectations will remain moderate, with wage growth still well behind consumer price inflation and “in line with the target” of 2-3 per cent inflation.
De-globalization drives up prices
However, Mr Lowe is less optimistic about global economic and geopolitical developments, which he warned will make inflation less predictable and more difficult to keep low than it has been for the past 30 years.
“Supply-side developments have either been largely benign or favorable for managing inflation,” he said of the period between the 1990s and the COVID pandemic.
“The pressure on capacity in Germany was increasingly reduced by opening up global markets.
“In addition, rapid economic growth in China has lowered the relative prices of manufactured goods, and demographic trends around the world have led to an increase in the labor supply in the global economy.
“Importantly, we have also largely avoided the major wars that have been sources of inflation in the past.”
Mr Lowe said these global developments have made central bankers’ jobs much easier, but many of them are now reversing, creating additional complications in the cheap supply of goods and services.
“International trade is no longer growing faster than the world economy. Trading blocs are emerging and there is a step back from closer integration,” he warned.
“Unfortunately, today’s trade and investment barriers are being increased rather than eliminated.
“This will inevitably affect both living standard growth and the pricing of goods and services in global markets.”
spectrum of stagflation
Mr Lowe mentioned three other factors disrupting supply and thus putting upward pressure on prices.
The first is a decline in the working-age population in most developed economies and several large emerging economies, most notably China.
The second is climate change.
“Over the past 20 years, the number of major floods has doubled, and the frequency of extreme heat waves and droughts have also increased significantly,” noted Mr Lowe.
“These climate events disrupt production and affect prices.”
Finally, the transition to renewable energy to deal with this climate crisis is itself likely to result in near-term increases in energy costs.
Without using the term, Mr Lowe raised the specter of ‘stagflation’, an economic condition in which inflation is high despite a weak economy.
“Life is more complicated in a world of supply shocks; an adverse supply shock increases inflation and reduces output and employment,” he warned.
“Higher inflation requires higher interest rates but lower production, and fewer jobs require lower interest rates. It is likely that we will have to deal with this area of tension more often in the future.”
In light of this, Mr Lowe made a not-too-subtly urging on the federal government to continue with the household repair work it began last month.
“In a world of more frequent supply shocks, we will be better off if our labor and product markets are flexible so we can respond quickly and effectively,” he told an audience that included many business leaders.
“This includes fiscal policy flexibility, which requires maintaining a strong underlying structural fiscal position.”
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