Labor and Treasurer Jim Chalmers have a long way to go to address inflation - The Centre for Independent Studies
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Labor and Treasurer Jim Chalmers have a long way to go to address inflation

This week’s economic statement from Treasurer Jim Chalmers has answered some pressing economic questions. First and foremost, inflation will remain a serious problem for some time to come.

In many respects this was already obvious. Inflation is above 6%. Treasury now predicts that it will almost reach 8% by the end of the year before starting to fall.

If that past few years is any guide, this forecast must be treated more as loose guidance than a likely outcome. From inflation to wages to budget deficits and beyond, time and again the experts have predicted a quick return to normal without the need for politicians to make the tough choices.

Routinely these forecasts have not come to pass one reason we are in this mess to begin with.

The Treasurer is confident the RBA can restrain inflation without causing a recession. Yet, reading between the lines in Chalmers speech, it doesn’t look like Labor will substantially moderate its policy platform to accommodate the new economic reality.

Let’s start with what Chalmers got right.

He is correct that inflation is a problem at least partially out of Australia’s hands. Global supply chain issues are real, as is the energy price shock from the Russian invasion of the Ukraine.

More contentious, but still likely to be correct, is that hesitation and uncertainty on energy policy has contributed to (but not caused) Australia’s current energy woes.

Whether things would in fact be better in an alternative universe where Australia invested heavily in a renewable transition a decade ago is, at best, conjecture.

Regardless, our inability to stick to any energy policy be it renewables or additional thermal generation surely can’t have helped.

Chalmers is also right that the current bout of inflation hasn’t come from wages. The problem for Chalmers, and the Australia Institute who recently published a paper refuting the same claim, is that no-one is seriously arguing that it did.

The fear of a wages price spiral comes from concerns that this bout of inflation will feed directly into future wage growth, which will prolong the current inflationary episode.

In their paper, the authors from the Australia Institute produce three quotes about wages and inflation all of which clearly refer to this risk of future inflation.

Yet both the government and the unions are calling for some kind of inflation indexation for wages, an idea the Fair Work Commission seemed to partially endorse in the recent Minimum Wage decision.

This is why Chalmers beats up the straw man about wages not driving the current inflation crisis. The government is reluctant to admit their preferred wages policy is likely to contribute to future inflation and prolong the pain.

Especially if this policy of quasi-indexation shifts inflation expectations upwards.

Indeed, these wage rises are a central part of the government’s economic plan a theme Chalmers returned to several times.

It is funny how the same economic plan that was right for the different economic circumstances prior to the election, just happens to be the right one for the current inflation crisis too.

Yet Labor’s plan has always been weak, even somewhat fanciful; despite the vigour with which they supported it.

The centrepiece was a clean energy plan that would allegedly simultaneously cut emissions, cut power bills, create hundreds of thousands of jobs, spur tens of billions of dollars in investment, boost economic growth and create opportunities in the regions and key industries.

Regardless of whether such a plan can deliver even a fraction of its supposed benefits in the years to come, it will likely have a negligible (or negative) impact on inflation in the short term.

Labor’s other initiatives are relatively minor. In addition to spruiking wage rises both for specific industries and broadly across the economy, the government will further boost childcare subsidies and increase the PBS subsidy.

Again, to the extent these measures have any impact on the macroeconomic situation at all, they would be expected to increase, not decrease, inflation.

Labor’s plans are all driven by government spending. Perhaps this is why they seem not to countenance the fact that excessive stimulus both monetary and fiscal made a significant contribution to this inflationary episode.

It is ironic that many on the left who would deny government’s role in this, instead claim ‘excessive profits’ are causing inflation. Yet it is excessively boosted demand, combined with supply shortages, that creates the conditions for ‘excessive profits’ to exist in the first place.

So where does this leave us?

Treasury sees inflation remaining above the target band for 18 months, if not longer. Unemployment is predicted to stay at near 50-year lows for the same period. Economic growth is down but wages will allegedly continue to trend upwards towards positive growth by 2025. And apparently there won’t be a recession.

This goldilocks scenario should be approached with as much scepticism as you can muster. There are significant downside risks on both sides of the forecast.

First, inflation may well go higher, and be sustained longer, than expected. For months now, following every CPI release, both the RBA and Treasury have revised their inflation forecasts upwards.

The RBA was caught flat-footed when inflation went under target in the late 2010s wishing inflation would return to target rather than taking decisive action to make it so and again last year when inflation started to pick up.

With global inflation still rising and the government remaining committed to its spending agenda, confident predictions of an inflation peak this year may not age well.

Conversely, after denying the need to act for several months, the RBA is now raising interest rates faster and harder than anything seen in the past three decades. It could overcompensate for previous excessive caution and cause a recession.

If that occurs, one wonders whether Labor will wheel out the same economic plan once again this time labelled as a perfect recession buster.

Simon Cowan is Research Director at the Centre for Independent Studies.