Chapter 2Background
Australia's cost of living crisis
2.1In the 12 months leading to the March 2023 quarter, the Consumer Price Index (CPI, the average change in prices paid by consumers for goods and services; the predominant measure of inflation in Australia) rose 7.0 per cent (see figure 2.1, below). The Australian Bureau of Statistics (ABS) identified the most significant price rises as related to dwelling purchases by owner-occupiers, gas and other household fuels, and furniture.
Figure 2.1Monthly CPI indicator, annual movement (%)
Source: Australian Bureau of Statistics, 'Monthly Consumer Price Index Indicator', ABS website, 26April2023.
2.2The October 2022–23 Budget warned of significant ongoing inflationary risks in the coming years:
There may be further or prolonged disruptions in global energy markets as a result of Russia's ongoing invasion of Ukraine. Recent flooding could drive food prices higher. Tighter labour market conditions than forecast could also add to underlying pressures. In contrast, tighter monetary policy in Australia and globally than is currently expected could have a faster than expected impact, resulting in a quicker return of inflation to target.
2.3In November 2022, the Reserve Bank of Australia (RBA or Reserve Bank; Australia's central bank) issued a statement outlining its analysis of the inflationary environment in Australia:
Strong demand and ongoing supply issues boosted goods price inflation in the September quarter, as non-labour cost pressures continued to be passed through to consumers. Some of these upstream cost pressures have eased in recent months, but it will take some time before this affects the prices paid by consumers. Higher input costs and strong demand have also contributed to a pick-up in services inflation in recent quarters, while rent inflation has picked up in response to tight rental market conditions.
2.4The RBA identified fuel, new dwelling purchases, consumer durables, and groceries as the primary contributors to recent rises in the CPI.
Figure 2.2CPI by group, weighted average of eight capital cities, annual change
Source: ABS data, chart from Business Council of Australia, Submission 20, p. 4
2.5In February 2023, the RBA stated:
Inflation is likely to have peaked around the end of 2022 and is forecast to return to the target range over coming years. The central forecast is for CPI inflation to decline to 4¾ per cent over 2023 and to around 3 per cent by mid-2025.
2.6The challenges Australians faced with the rising cost of living was a significant feature of the then-Labor Opposition’s commitments to the Australian people as part of the 2022 election campaign and following the election.
2.7Then Opposition Leader Anthony Albanese MP and his frontbench colleagues made a significant number of statements indicating that cost of living pressures would improve under a Labor Government. These included:
'I’ll say this very clearly. They [Australians] will be better off under a Labor government';
'We’ve got policies about getting power bills down. We’ve got policies…to get real wages moving again'; and
'People will be seeing in their bank accounts what the change of Government means. People will be seeing in their bank accounts a wage increase…'.
2.8However, the evidence the committee has received throughout the inquiry to date is that these commitments have not materialised. Rather, cost of living pressures have worsened into a cost of living crisis in the last six months.
Real wages
2.9Alongside and compounding the significant impact of increasing costs of living has been the failure of wages to keep pace with inflation.
2.10Changes in wages over time (the price of labour) are generally measured by the Wage Price Index (WPI). Australia's WPI has shown a steady increase in the cost of labour over the two years from September 2020 to September 2022, in which the WPI rose from 1.4 per cent to 3.1 per cent—the highest level in 9years—driven by the strong employment market and recent historically low unemployment that followed the Coalition Government's response to the COVID-19 crisis. These increases, however, remain well below recent inflation, meaning real wages (that is, the ability of people to buy things with their pay) have fallen during this period (see Figure 2.3, below). As one commentator noted in late 2022, 'given the 7.3% rise of inflation over the past year, wages in real terms fell 3.9% in the past year—the biggest fall on record'.
2.11The RBA estimated that real wages in September 2022 had fallen to 2010 levels.
2.12This decline in real wages is forecast to continue into 2023, despite comments by members of the Government, including the Prime Minister, who said in April2022 that, 'we have a plan to actually lift wages'.
Figure 2.3Index of real wages
Source: data from Australian Bureau of Statistics, 'Wage Price Index, Australia', ABS website (accessed 1 May 2023).
2.13The Reserve Bank has advocated for a cap on wage growth of around 3.5percent (well below inflation forecasts over the coming years) to avoid entrenching higher inflation.
2.14The RBA has also warned of the risk of a 'wage-price spiral' emerging, in which inflation may lead to workers demanding higher wages to meet higher living costs, which would in turn increase input costs, thereby forcing firms to raise prices and triggering further inflation.
2.15Prior to recent inflationary increases, the Governor of the Reserve Bank, DrPhilip Lowe, had stated that wage increases well above 3 per cent were required to maintain inflation within target. However, this position shifted in response to the current inflationary environment. On the basis of soaring inflation and the risk of the emergence of a wage-price spiral, the RBA has more recently warned that wage increases at or beyond recent CPI figures would put more pressure on inflation to rise—a position echoed by industry.
2.16During the final leaders' debate of the 2022 election, then-Prime Minister, theHon Scott Morrison MP, similarly expressed his concern regarding a potential wage price spiral, noting that in the current environment, a wage increase of 5percent or more would fuel interest rates and a rising cost of living.
2.17The Secretary to the Treasury, Dr Steven Kennedy PSM, has also raised concerns regarding wage increases contributing to inflationary pressures unless coupled with productivity gains in his statements to the Senate Economics Committee in February 2022.
2.18Critics have challenged the current link between wages and inflation, however, questioning the logic of advocating real wage cuts in the face of mounting cost of living pressures. Ms Elizabeth Watson-Brown MP, for example, cited a report by the Australia Institute to argue in the House of Representatives that, 'despite what some commentators say, inflation is in no way being caused by wages'. The Australia Institute report to which she referred concluded:
The fear that wage growth has, or could, play a significant role in Australia’s inflation typically ignores the fact that…real wage growth is at historically low levels and has been for some time.
2.19Mr Greg Jericho, Policy Director at the Centre for Future Work (an initiative of the Australia Institute), told the committee:
[T]there is no evidence that wages are currently driving inflation or the cost of living. In fact, we're currently experiencing an historic decrease in real wages…We have had decades of industrial relations policy essentially designed to limited the growth of wages… [O]ver the past year, real wages have fallen by more than four per cent and the value of real wages in now back where it was in 2009. This is an historic drop.
2.20Mr Jericho further claimed that profits were having a greater impact on inflation than wages (see below).
2.21Dr Marion Kohler from the RBA told the committee that inflation had been quite broadly based, meaning that most groups in Australian society had seen their cost of living increase by roughly the same amount. During 2020, she noted that CPI had grown faster than households' disposable incomes, 'meaning that real incomes have declined over time'. However, Dr Kohler told the committee that the strong labour market has been putting upward pressure on wages.
2.22The risk of a wage price spiral has been repeatedly emphasised by the ReserveBank. The Governor has noted that the Bank remains alert to the potential for wages to add additional pressure to inflation and the importance of avoiding this in his public statements in April, March, February, November, and December 2022.
Addressing inflation
Policy options
2.23Two broad categories of policy responses are available to influence the economy: monetary and fiscal policies. Monetary policy consists of measures to influence borrowers and lenders by changing funding costs and the supply of credit. In Australia, monetary policy falls under the purview of the RBA, which sets the 'cash rate'; that is, the rate at which banks borrow and lend to each other. The RBA is independent of government and accountable to the Parliament (although it is required to consult with government). The RBA is statutorily required to pursue price stability, full employment, and the 'economic welfare of the Australian people'. The Bank's other functions include maintaining the stability of the financial system; supporting a secure, stable, and efficient payments system; efficient and effective banking services to the Australian Government; and providing secure and reliable Australian banknotes. The inflationary environment and monetary policy responses designed to address inflation are discussed below.
2.24The second set of policy responses available to government are fiscal. Fiscal policy is the use of government spending and taxation to influence the economy. The fiscal approach taken by the current Labor Government and its impact on the cost of living crisis are discussed below.
The Reserve Bank's role
2.25The RBA aims to maintain consumer price inflation between 2 and 3 per cent, on average, over time. The Bank has identified returning inflation to this target range as its 'most important focus area', stating:
Achieving the inflation target preserves the value of money and facilitates strong and sustainable growth in the economy over the longer term. This helps businesses and households make sound investment decisions, underpins the creation of jobs and protects the savings of Australians.
2.26To bring inflation within target, the RBA sets the cash rate through the Reserve Bank Board (the Board), which meets monthly. During the COVID-19 pandemic, the cash rate had fallen to an historic low of 0.1 per cent. In response to rising inflationary pressures from early 2022, the Board increased the cash rate target at each of its ten meetings from May 2022, reaching 3.6 per cent in March 2023 (see Figure 2.4)—the highest rate since 2013. The Board paused its rate rise increases at its 5 April 2023 meeting, maintaining the target rate at 3.6 per cent.
Figure 2.4Cash Rate Target
Source: Reserve Bank of Australia, Cash Rate Target, https://www.rba.gov.au/statistics/cash-rate/ (accessed 17 April 2023)
2.27Increases in the cash rate directly influence the interest rates offered by banks and lenders, thereby increasing the cost of borrowing for Australian businesses and households. For more on the impact of rate rises on housing affordability, see Chapter 5.
2.28Dr Marion Kohler from the RBA told the committee:
We understand that some people are finding the rise in interest rates difficult to manage and that others will have to cut back on discretionary spending. However, higher interest rates are necessary to ensure that the current period of high inflation and cost-of-living pressures does not persist too long.
2.29Dr Kohler emphasised the RBA's overriding focus on tackling inflation, stating:
[The Reserve Bank's] mandate is to manage aggregate inflation…We have one tool, which is the interest rate, and it is a blunt tool. The RBA board is mindful of that and is looking at [affordability and cost of living] issues when setting policy, but it doesn't really have tools beyond the interest rate to address it. So there are trade-offs that we need to make. We just don't have the right tools to hit all those targets.
Cost of living drivers
2.30Evidence before the committee pointed to a series of external drivers of inflation: disruptions associated with the COVID-19 pandemic, the invasion of Ukraine by Russia, and repeated adverse weather events—predominantly on Australia's east coast. These areas are outlined below, with critiques and additional factors discussed in the following thematic chapters.
Supply shocks and external factors
2.31Dr Kohler told the committee that the rising cost of living in Australia was largely the result of unpredictable supply shocks, pandemic disruptions to global supply chains, the Russian invasion of Ukraine, flooding on the east coast, and strong growth in domestic demand in many countries. She described the context surrounding mounting inflation, as follows:
[T]he story started initially with global supply chain problems…There was then a further escalation of the Russian invasion of Ukraine, where we saw certain food and international energy prices pick up. Some of that flowed back to here, through global markets. Then we also had the east coast floods last year, which brough supply problems into fruit and vegetable markets, coal markets and domestic energy prices around the same time…
Initially it was very contained to traded goods…We've seen over the past year, increasingly, a broadening-out of inflation pressures into domestically provided goods and services.
2.32Mr Tom Rosewall, also from the RBA, noted that high inflation was not unique to Australia and had been a feature of most advanced economies since the pandemic.
COVID-19 disruptions
2.33Inflation has been driven in part by shifting demand and supply related to the COVID-19 pandemic. Public health measures—including periodic major lockdowns in key manufacturing countries, like China—impacted global production, reduced consumption, and disrupted supply chains.
2.34Mr Luke Yeaman, Deputy Secretary at the Department of the Treasury, pointed to shipping and transport costs as having been disproportionately impacted by the surge in inflation resulting from the pandemic. He described to the Senate Economics Legislation Committee the inflationary impact of the pandemic, as follows:
There was a very significant shift…away from services across many countries as people were locked down and couldn't undertake the normal things that they would undertake…so they shifted consumption very much to goods. That led to a very sharp increase in the amount of goods demanded across the economy, which put a lot of strain on supply chains…That led to a surge in prices. At the same time, many of the distribution centres…that generate most of those goods were suffering lockdowns…which meant that their own input costs were rising and there was constrained supply.
Those factors together led to very sharp increases in prices across a range of goods.
2.35Further, economies around the world experienced what Treasury Secretary, DrStephen Kennedy PSM, described as 'extraordinary [government] stimulus in response to the pandemic'. These unprecedented fiscal measures supported the economy through the shutdown that the health response to the pandemic. Measures like JobKeeper, the Cashflow Boost and Pandemic Disaster Leave payments ensured that individuals and businesses made it through the pandemic.
2.36The IMF noted that Australia’s 'strong health and economic policies allowed for quick economic recovery from initial COVID-19-related lockdowns in 2020'.
2.37It further stated that:
Underpinned by sound macroeconomic fundamentals, large-scale fiscal and monetary policy support helped lift the economy out of its first recession in three decades in the wake of the initial COVID-19 waves in 2020. Economic activity recovered to well above pre-pandemic levels by the second quarter of 2021, faster than in most other advanced economies.
2.38Whilst supporting 'a strong economic rebound’, combined with loose monetary settings, this contributed to boosted consumption and increased excess demand.
2.39Loose fiscal settings were common across developed economies. Economists from the University of Western Australia’s Economics Department noted that in response to the pandemic:
Governments responded to the pandemic with programs to support incomes during lockdowns. Globally central banks also increased liquidity.
Ukraine conflict
2.40The Russian invasion of Ukraine on 24 February 2022 drove cost of living pressures in two principal ways. First, as Ukraine was a major supplier of food and agricultural commodities (including over a third of the world's wheat and half global exports of vegetable oil), the conflict triggered global food shortages and food price spikes—particularly in developing countries. Food exports from Russia (responsible for nearly 8 per cent of global cereal exports and 20percent of vegetable oil supplies) were also impacted by the war and ensuing sanctions imposed by western countries, contributing to a near-doubling of cereal and oilseed prices from mid-2020 to mid-2022. The October 2022–23 Budget noted that global food prices were 50 per cent higher than they were at the start of the pandemic. See Chapter 6 for more on the affordability of food and groceries.
2.41Second, sanctions imposed on Russia and the withholding of gas and oil supplies by Russia in retaliation for western support for Ukraine, triggered increases in global energy prices in 2021 and 2022. Global energy price increases drove up domestic energy prices and contributed to broader price increases due to higher transport and production costs. The October 2022–23 Budget noted that global energy prices had doubled since the start of the pandemic.
2.42See Chapter 4 for a discussion of the significance of the Ukraine conflict for domestic energy prices.
Adverse weather events
2.43Recent successive flooding events and heavy rain on the east coast in 2022 wiped out crops and food supplies, and created logistical challenges to moving agricultural inputs and produce, contributing to food shortages and increasing food prices throughout the year. Flooding in New South Wales in mid-2022 led to shortages of fruit and vegetables, impacting up to $1 billion-worth of fresh produce from the Sydney Basin.
2.44The Red Cross reported its busiest year on record for its Emergency Services teams in New South Wales.
2.45See Chapter 3 for the impact of cost of living pressures on the not-for-profit sector and Chapter 6 for more on the affordability of food and groceries.
Corporate profits
2.46The Australia Institute has argued that corporate profits were contributing to inflationary pressures.
2.47Globally, corporate profits have been particularly high within the resources and energy sectors.
2.48Industry analyst, James Thomson, noted that from 2020, resource companies have seen record profits in dollar terms, but not necessarily record margins:
While profit has been rising on the back of high commodity prices, tight labour market conditions and supply chain disruptions have been eating into some of those gains. A lot of production is also sold on long-term contracts so the high spot prices we are seeing in the market do not completely flow through to revenue and profit gains for producers.
2.49National Australia Bank senior economist, Mr Brody Viney, described the tendency of firms to pass on higher costs to maintain profit margins as a 'critical factor' driving Australian inflation.
2.50On 8 November 2022, Mr Luke Yeaman, Deputy Secretary at the Department of the Treasury, told the Senate Economics Legislation Committee that 'the main driver of larger corporate profits and a larger profit share is the extraordinary commodity prices we have seen to date'.
2.51However, Mr Tom Rosewall from the RBA addressed these arguments during his evidence before the committee, noting:
At an aggregate level the profit share across the economy has increased in the latest data. But when you extract from the mining sector and the role of high commodity prices and look at the rest of the economy, the nonmining economy, it's the case… that the profit share [as a proportion of the national accounts] has been broadly stable.
2.52Mr Luke Yeaman, Deputy Secretary at the Treasury, similarly told the committee the key driver of higher profit shares is the impact of higher commodity prices for the mining sector. Mr Yeaman said that if mining sector profits were excluded, current conditions were 'not out of line with historical averages'.
2.53Supporting this position, Ms Cassandra McCarthy of Glencore Australia noted that the resources sector was cyclical, meaning years with higher profits offset years in which companies may face losses.
2.54The Business Council of Australia (BCA) similarly submitted:
…there is no credible evidence of the profitability of businesses contributing to higher inflation…Commentary to the contrary is misleading and unhelpful.
2.55BCA further stated:
The suggestion that business profiteering is to blame for cost of living pressures is simply not supported by economic data…profits in the non-mining sector as a share of the economy have steadily fallen the past couple of decades.
2.56With regard to claims that profits in the mining industry were driving inflation, the Minerals Council of Australia noted that '[a] strong mining industry is critical for securing Australia's prosperity', and pointed to the industry's contribution of 2.4 trillion in resources and export revenue over the last decade.
2.57Ms McCarthy also emphasised the important role played by the resources sector for the Australian economy, telling the committee that over recent years, strong commodity prices had led to 'significantly higher corporate tax and royalty revenue for federal and state governments'.
Internal and other factors
2.58The committee heard evidence from witnesses that reflected the internal drivers and other factors that were placing increased pressure on inflation and the cost of living for consumers. These pressures included the Government’s fiscal policy, corporate profits, and domestic economic factors outlined below and in later chapters.
2.59The BCA also attributed rising costs of living to:
emergency financial support and reduced spending by Australians during lockdowns that increased the cash reserves of many households;
pent-up demand following the pandemic;
labour shortages resulting from the halt on migration and the closure of businesses during the pandemic; and
record low interest rates that led to a spike in borrowing (particularly for houses).
Government's fiscal policy response
2.60This section outlines some of the Government's fiscal policy responses to cost of living pressures.
Fiscal policy and its impact on cost of living pressures
2.61The committee received evidence noting the relationship between fiscal policy settings and the cash rate. Put simply:
…the lower is government spending, the less likely are future interest rate increases. The RBA can use monetary policy to bring inflation back to normal by stifling demand, but not without severely hurting mortgage holders and borrowers and ultimately recessionary risks through increased borrowing costs.
2.62That is, where imprudent fiscal policy drives inflationary pressures and therefore costs of living, the RBA’s necessary fiscal response will also increase pressures on households through increasing mortgage rates. Similarly, the inverse is true; '[t]o align inflationary expectations in the right direction, it is important for the government to curtail excess government spending.'
2.63Dr Lowe of the RBA echoed this in a statement to the Senate Economics Committee, noting, 'it’s helpful if monetary policy and fiscal policy are not working in opposite directions'. Economists from the University of Western Australia went further, telling the Committee that 'if the government is running a structural deficit, its fiscal policy is expansionary'. The expert economists went on to clarify that 'overall, the Federal Government’s fiscal policy, as set out in the 2022–23 October Budget, is not complementary to the RBA’s monetary policy.'
2.64Based on this evidence, the Government’s current fiscal policy therefore is contributing to the cost of living crisis in two ways. First, adding to inflationary pressures by increasing net income and inflationary expectations. Second, it means that the RBA is required to further increase the cash rate to bring down inflation, contributing to mortgage stress for many property owners.
2.65Dr Timo Heckel of the research school of economics at the Australian National University, noted that 'fiscal policy could do more' to address the cost of living crisis, while professional economists and commentator Dr Chris Richardson was even more blunt, stating, '[t]here are several reasons for budget repair, but right now it can take the pressure off inflation'.
The Government's approach to cost of living pressures
2.66Finance Minister, Senator the Hon Katy Gallagher, said the October budget would have a 'cost of living lens applied to it' with a view to offsetting the inflationary challenges faced by households and businesses.
2.67The Prime Minister, the Hon Anthony Albanese MP, said his Government would not implement broad payments designed to alleviate cost of living pressures on households, stating:
…the easy option would have been for us to funnel these savings straight into a cash-splash, a one-off giveaway to buy a headline. Cheap politics and hugely expensive economics. Not just because of the dollar cost. Not just because that's exactly the sort of short-term approach that got Australia into this situation. But because the untargeted spending would make the problem worse. Instead of helping households, it would only add to the inflationary pressures that are eating away at family budget and devaluating wages. What’s more it would put the independent Reserve Bank in a position where it would likely raise interest rates higher than it otherwise would. Fiscal policy needs to work with monetary policy, not contradict it.
2.68The Government in its October 2022 budget, announced cost of living relief as one of its three budget priorities. The budget outlined a five-point plan to deliver cost of living relief:
making early childhood education and care more affordable;
reducing the cost of essential medicines;
expanding paid parental leave;
improving housing supply and affordability; and
getting wages moving.
2.69However, the committee notes that in the assessment of the Treasury, the impact of the October 2022 budget on inflation would be 'broadly neutral' over the forward estimates, reflecting that these measures will neither increase nor decrease the inflation inherent in the economy.
2.70The Committee also notes that, of the measures included in the five-point plan, measures relating to childcare, paid parental leave, and housing are not due to commence until 1 July 2023, with aspirational targets being used to drive some outcomes and the impact of these measures unlikely to deliver immediate relief to consumers in the short term.
2.71The committee further notes in relation to measures to increase wages, these have yet to see realised changes to the real wages of workers, and, as has been outlined above, may risk the realisation of a wage price spiral.
2.72See Chapter 5 for more on housing affordability.
Other fiscal responses
2.73On 9 December 2022, the Federal Government announced that it had reached agreement with Queensland and New South Wales to impose a temporary price cap of $125 per tonne of coal used for electricity generation.
2.74Subsequently, the Commonwealth Government recalled Parliament and on 15 December 2022, the Parliament passed the Treasury Laws Amendment (EnergyPrice Relief Plan) Bill 2022 that would impose an 'emergency price order' of $12 per gigajoule of uncontracted gas (See also Chapter 4).
2.75Introducing the Bill, the Treasurer, the Hon Dr Jim Chalmers said:
This bill and this government recognises that Australian households and businesses are confronting unsustainable, unacceptable energy price rises. We respond today with urgent, targeted, meaningful action—to take some of the sting out of these price rises, and to provide direct energy bill relief.
2.76At the time of writing, no energy bill relief has been provided to Australian consumers and the Government is yet to fulfil its election commitment of delivering a reduction in energy bills of $275.
2.77See Chapter 4 for more on energy affordability.
2.78On 5 September 2022, the Government announced the 'largest indexation increase to payments in more than 30 years' that would be received by 4.7million Australians, including by increasing:
the Service Pension, Age Pension, Disability Support Pension, and Carer Payment by $38.90 per fortnight for singles and by $58.80 per fortnight for couples;
the JobSeeker Payment for singles without children by $25.70 per fortnight and by $23.40 per fortnight for those with partners;
the Parenting Payment for singles by $35.20 per fortnight and by $23.40 per fortnight for those with partners; and
increases to other payments.
2.79The committee notes that these increases did not require any decision by the Government and are an effect of long-standing legislation. It would have been unusual for the Government not to provide these legislated increases.
2.80See Chapter 3 for more on income support payments.
Interim committee findings
Finding 1: Real wages are not growing and have deteriorated due to high inflation. Finding 2: The most effective way to reduce inflation is to have monetary policy and fiscal policy working in the same direction. Finding 3: While the cost of living in Australia is being driven by a range of factors, including supply shocks and adverse weather events, domestic policy settings are also major contributors to inflation. |