Chapter 2Overview of economic conditions
2.1This chapter firstly provides an overview of the broad economic conditions that reflect the cost of living crisis and, to some extent, have also contributed to it.
2.2The also chapter considers Australia's economic growth, unemployment rate, wages, inflation and interest rates. The chapter then sets out how the Labor Government's response to high inflation has, far from addressing the crisis, actually contributed to it continuing, and discusses the negative impact of key government policies on productivity and alternative approaches that could improve productivity.
2.3Although the committee had previously canvassed some of these issues in the interim reports, the committee sought expert analysis and potential solutions to these bigger economic questions from several of the nation's leading economists by inviting them to give evidence at the public hearing on 7 August 2024 in Sydney. The views of these economists are discussed throughout this chapter.
Economic conditions
2.4The Australian Bureau of Statistics measures and reports on the key economic indicators that show the relative health of the economy over time. These indicators include:
gross domestic product (GDP);
living cost indices;
household consumption;
data on the labour market (including wages and workforce participation); and
inflation, reported through the consumer price index (CPI).
Gross Domestic Product
2.5The Australian economy grew by 1.5 per cent over the 2023–24 financial year, and by a mere 0.2 per cent in the June quarter 2024. Concerningly, the June quarter represented the sixth consecutive quarter in which GDP per capita fell, with GDP per capita over the year falling 1.0 per cent. This confirmed an 18‑month per capita recession.
2.6In addition, the annual growth of 1.5 per cent is the weakest annual GDP growth (excluding the COVID-19 pandemic) since 1991–92, a year that included the gradual recovery from Labor's 1991 recession.
2.7Subdued household demand from reduced discretionary spending detracted 0.1 per cent from GDP growth. Government spending contributed 0.3 per cent to GDP, the same contribution as the previous quarter, with the Australian Bureau of Statistics concluding that this figure was largely driven by social benefits to households. Critically, the Reserve Bank of Australia (RBA), in its August Statement on Monetary Policy, projected stronger than previously expected public demand, reflecting the significant increase in the Labor Government's spending, combined with additional expansionary budgets at the state and territory level.
2.8As noted by commentators, Australia is in a persistent per capita recession, given this is the sixth consecutive quarter of negative GDP per capita growth. To put this another way, the population is increasing faster than GDP, so individuals on average are experiencing a 'recession' in terms of their spending ability and standard of living.
2.9Unfortunately, the RBA has signalled that this trend may continue. The RBA's Dr Sarah Hunter told the committee that the RBA:
… also know, too, the tangible way, I guess, that we see in the data in terms of what we have been talking about and the struggle for households and that consumption per capita has been falling now for a number of quarters. We think it's got potentially a little bit further to go before it troughs [emphasis added].
Living cost indices
2.10The Australian Bureau of Statistics releases selected living cost indexes regularly. These indexes measure movements in various categories of prices, and report this data by the type of household, according to the primary source of income it receives:
employees, whose principal source of income is wages and salaries, and who recorded the strongest annual rises in living costs in the June data release because of interest rate increases in mortgages;
age pensioner households, who receive the age pension or veterans' affairs pension;
recipients of other government payments; and
self-funded retirees.
2.11A fifth index, the Pensioner and Beneficiary Living Cost Index, measures changes in out-of-pocket living expenses for the combined age pensioner and other government transfer recipient households.
2.12Recent releases from the Australian Bureau of Statistics show the trend in the cost of living crisis. In the June release, for both the quarter and the twelve months to the June 2024 quarter, all five indexes increased (see Figure 2.1). The main contributors to the increases were:
insurance and financial services, driven by the rising cost of insurance and mortgage interest rates;
housing, driven largely by rents and electricity prices; and
food and non-alcoholic beverages, driven by price rises in fruit and vegetables because of unfavourable growing conditions.
2.13Employee households recorded the largest annual rise in living costs of all household types, at 6.2 per cent for the year. This followed a 6.5 per cent rise in the previous quarter, and 9.6 per cent in the June 2023 quarter. Put simply, households' living costs increased by 15 per cent over the two years to June 2024.
Figure 2.1Selected Living Cost Indexes (LCIs) by household type and CPI, Australia, quarterly and annual movement (%)
Source: Australian Bureau of Statistics,Selected Living Cost Indexes, Australia, June 2024, abs.gov.au/statistics/economy/price-indexes-and-inflation/selected-living-cost-indexes-australia/latest-release (accessed 4 September 2024).
Household consumption
2.14Consumers comprise around 55 per cent of the economy. Household consumption has a direct impact on the performance of particular sectors of the economy with the retail sector, for example, particularly affected by current household consumption figures.
2.15Household consumption in the June quarter 2024 experienced the weakest growth rate (-0.2 per cent) since the September 2021 quarter of the COVID-19 pandemic lockdown.
2.16Discretionary spending fell 1.1 per cent for the June quarter 2024, with this figure affected by reductions in spending on:
transport services (-4.4 per cent); and
hotels, cafes and restaurants (-1.5 per cent).
2.17Essential spending increased by 0.5 per cent for the June quarter 2024, with spending on food decreasing by -1.0 per cent as households chose to purchase affordable options to reduce their supermarket bills and support increasing mortgage and rent payments.
2.18Evidence from Australia's major supermarkets themselves suggests that many consumers are shopping at two to three different supermarkets each week to buy what they can at a discount, before going to their primary or better-known retailer.
2.19The RBA informed the committee at the 7 August 2024 hearing that the recent softening of consumption 'is a big part of why we think the economy has rebalanced. We think the policy [of increased interest rates] is working'.
2.20However, Mr Warren Hogan from Judo Bank noted that the stalling of consumption growth as currently witnessed had only been experienced on four previous occasions in the last forty years—during the 1980s recession, the 1990s recession, the Global Financial Crisis and at the beginning of the COVID-19 pandemic. He pointed out that business investment during those periods was on average down by around 16 per cent:
At the moment, investment's up by five. That's telling you that this downturn is exclusively being driven by a squeeze on household incomes because of higher inflation, the bracket creep that comes with it, and, of course, higher interest rates. That is not the usual experience for Australia. This is a genuine step backwards in people's standards of living. They can't generally live the same lifestyle that they did two years prior.
The labour market
2.21According to Dr Shane Oliver, Chief Economist at AMP, households have managed through the cost of living crisis by using their savings, remaining in employment, and by working longer hours. However, the 'problem is that if the jobs market starts to slow then the equation becomes dramatically different'.
2.22A significant rise in unemployment can indicate an economy is moving towards a recession. Changes to the hourly rate of wages and the proportion of jobs recording a wage change may point to wages pressures in the labour market, ultimately costing Australians' jobs and the financial stability that comes with them.
2.23If consumers' ability to purchase goods and services is reduced because prices are increasing faster than people's nominal incomes and bracket creep is increasing the amount of tax they pay relative to their income, they may then seek wage increases to compensate for their reduced ability to purchase goods and services, which may lead to more money circulating in the economy. As such, while 'real' wages (that is, wages adjusted for inflation) may not increase, or even may go backwards, inflationary pressures increase, creating an unvirtuous cycle. This can only be offset with productivity gains.
2.24As the former Governor of the RBA, Mr Philip Lowe, noted:
The best way to achieve a moderation in growth in unit labour costs is through stronger productivity growth, which would also underpin durable increases in real wages and our national wealth and make more resources available to fund the public services that people value.
2.25As wage increases increase costs to firms, employers may reduce the number of workers they employ and/or the number of hours they employ people.
2.26To put this another way, wages growth and unemployment data may give an indication of the direction the economy is headed by reflecting how much money may be circulating in the economy in the coming months due to an increase to the unemployment or underemployment rates. Pressures in the labour market can be identified via:
the unemployment rate;
the underemployment rate;
the participation rate; and
how much wages increase (if at all).
The relationship between interest rates and unemployment
2.27The RBA is required, under its mandate, to set monetary policy (through interest rates) that balances both inflation and full employment. All things being equal, if inflation is within the acceptable target band of two to three per cent and unemployment begins to increase, the general expectation is that the RBA will start cutting interest rates to avoid a recession.
2.28Unlike inflation (as outlined below), the RBA does not have a numerical target for full employment, because full employment cannot be encapsulated by a single measure that can be directly observed, and it changes over time as the structure of the economy evolves. As Dr Sarah Hunter of the RBA noted, the Bank does not 'focus overly on the unemployment rate'.
2.29Dr Hunter also informed the committee at the 7 August 2024 hearing that 'we are still hearing, generally speaking, when we average it all out, more reports of labour shortages than were typical pre COVID and more reports of capacity constraints than were typical pre COVID'.
2.30This view was echoed by small and medium business representatives in evidence to the committee, particularly from members of the hospitality and manufacturing sectors.
2.31Mr Alan Oster, the Group Chief Economist at National Australia Bank, told the committee that, according to quarterly consumer surveys the National Australia Bank had carried out, concern about 'the cost of living has gone up, but the worry about losing jobs has gone down'.
2.32However, seasonally adjusted unemployment has marginally increased from 3.9 per cent to 4.1 per cent since Labor came to government.
2.33Professor Richard Holden expressed concern about multi-year enterprise bargaining agreements, 'which make it very hard to get inflation under control' sooner rather than later.
2.34This was supported by Mr Warren Hogan from Judo Bank who pointed out that as a result:
… our labour market is not shifting in a way that reflects economic circumstances. There is a scenario in the next few years where, if our economy is weak enough and wages don't fall, because they're baked in at two to three years, then businesses will have to start laying off workers because they can't afford them.
2.35Mr Hogan was of the view that previously, the main macroeconomic issue for the Australian economy was unemployment. However, this has shifted and the 'the challenge for our labour market in this country over the next five to 10 years is ensuring that the workers' skillset that sits there matches up with the jobs that we've got and need to have'. This, he suggested, 'comes down to issues of education, training, incentives for business to train and, most importantly, flexibility in the labour market'.
Current unemployment figures
2.36The Treasury noted at the 16 August 2024 hearing that broad measures of capacity, such as job vacancies, 'are still at high levels but they have come off quite materially'.
2.37In broad terms, 'hours worked across the economy have also been coming off', even though the number of people in work has still been growing.
2.38Treasury expected 'at some point, that will become exhausted and you'll see a slightly larger increase in the heads [number of people in work] increase in unemployment'. Further, growth in wages 'appear to have peaked, and from our read, look to be coming off'.
2.39As noted, Australia's unemployment rate as at September 2024 (in trend terms), was 4.1 per cent compared to 3.9 per cent in May 2022 (see Figure 2.2). The participation rate was 67.2 per cent, while the employment to population ratio was 64.4 per cent. The underemployment rate was 6.4 per cent.
2.40In September 2024, total monthly hours worked in all jobs increased by 0.2 per cent compared with the previous month, and by 1.9 per cent across the year.
Figure 2.2Unemployment rate—September 2024
Source: Australian Bureau of Statistics, Labour Force, Australia, September 2024, abs.gov.au/statistics/labour/employment-and-unemployment/labour-force-australia/latest-release.
Wages
2.41The Wage Price Index (WPI) measures changes in the price of labour. As of the June quarter 2024, the seasonally adjusted WPI rose 0.8 per cent for the quarter and 4.1 per cent for the year. Although the price of labour dropped during the COVID-19 pandemic, it largely increased from June 2021 until December 2023 (see Figure 2.3). Annual growth has remained at 4.0 per cent or above since the September quarter 2023, where:
private sector wages rose 4.1 per cent; and
public sector wages rose 3.9 per cent.
2.42By industry sector, the mining industry recorded the highest quarterly rise in wage growth, with an increase of 1.3 per cent. Retail trade and the health care and social assistance industries recorded the lowest quarterly rise in wages, at 0.2 per cent. However, the health care and social assistance industry recorded the highest wages growth through the year, of 5 per cent.
Figure 2.3All sector Wage Price Index, quarterly and annual movement (%), seasonally adjusted
Source: Australian Bureau of Statistics, Wage Price Index, Australia—June 2024, abs.gov.au/statistics/economy/price-indexes-and-inflation/wage-price-index-australia/latest-release.
2.43The RBA informed the committee at the 7 August hearing that their view was 'real wages growth will pick up a bit from here over the forecast horizon', although the 'process is going to be a bit choppy as we go through the next couple of years'.
2.44Dr Shane Oliver, of AMP, noted that wages growth has not kept pace with CPI inflation:
Since the end of 2019—and most of the problems started in 2022—the cost of living, CPI, has gone up 19 per cent and wages have gone up 13 per cent. The wage number is one-quarter out. If you assume one per cent wages growth in the June quarter then it's gone up 14 per cent, which means a five per cent gap. People's real wages have gone down five per cent.
2.45Taking into account other factors such as bracket creep, real disposable income has fallen 8.7 per cent on a per capita basis from March 2022 to June 2024 (see Figure 2.4). This has been driven by the combination of anaemic GDP growth and persistently high inflation, and the accompanying stagnant real wages growth.
Figure 2.4Cumulative decline in living standards under Labor since March 2022
Source: Derived from ABS data on Gross Disposable Income, Final Household Consumption Expenditure and Estimated Resident Population
2.46This highlights the finding of the committee's First Interim Report, published in May 2023, that 'real wages are not growing and have deteriorated due to high inflation'.
2.47The Labor Government is yet to note or acknowledge the findings of that report.
Inflation and the Consumer Price Index
2.48Inflation in Australia is measured through the CPI. The CPI measures household inflation by reporting on changes in prices to categories of household expenditure, through both headline inflation (or the average price increase of all goods and services that Australian households are consuming) and underlying inflation, which excludes more volatile items that have particularly large price changes, like petrol prices because of global market developments, or food prices impacted by adverse weather events. Headline CPI does not measure mortgage payments, but it does look at the cost of rents and building new dwellings for owner-occupiers. The impact of interest rate increases is measured in the living cost indexes for employees (see previous discussion above).
2.49Australia's inflation target is between two and three per cent. Many other central banks around the world have a similar target. The RBA's target of between two and three per cent inflation on a sustained basis is aimed at headline inflation.
2.50The CPI rose 1.0 per cent for the 2024 June quarter and 3.8 per cent for the twelve months to the June 2024 quarter, up from 3.6 per cent in the March quarter. This increase in annual CPI inflation was widely seen by economists and commentators as demonstrating the 'stickiness' of domestic inflation and its 'homegrown' nature, given that inflation is declining in almost all other comparable jurisdictions.
2.51The release of quarterly CPI on 30 October 2024 reflected a slowing in the rate of CPI increase, resulting from the temporary and artificial mechanism of energy price rebates implemented by the Federal Labor Government and some state Labor governments. However, annual Trimmed mean inflation, discussed below, was 3.5 per cent—still above the RBA's target range.
2.52Underlying inflation is measured using the Trimmed mean, which reduces the effects of irregular or temporary price changes that may impact the CPI. The Trimmed mean annual inflation ending in the September quarter was 3.5 per cent, the eleventh quarter in which Trimmed mean annual inflation was above the RBA's target band of two to three per cent. This followed the June 2024 quarter figure of 3.9 per cent annual Trimmed mean inflation.
Figure 2.5All groups CPI and Trimmed mean, Australia, annual movement (%)
Source: Consumer Price Index, Australia, Consumer Price Index, Australia, September Quarter 2024, abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release.
2.53Annual price increases for particular goods and services as at the September 2024 quarter included:
rental prices:6.7 per cent;
cost of new dwellings: 4.8 per cent, with significant differences between capital cities, for example, with Perth experienced annual price rises of 19.1 per cent, compared with 2.7 per cent in Sydney and 3.6 per cent in Melbourne;
electricity prices: a decrease of 17.3 per cent because of the Labor Government's $3.5 billion Energy Bill Relief Fund subsidy and state government electricity rebates in Queensland, Western Australia and Tasmania;
insurance prices: 14 per cent, easing from a 16.4 per cent annual rise at the March 2024 quarter; and
food prices: 3.3 per cent, unchanged from the previous quarter.
2.54Capturing the need for vigilance on inflationary pressures, Professor Richard Holden expressed concern that with inflation, 'everything's fine until it's not. And things change very rapidly'.
2.55Mr Warren Hogan of Judo Bank agreed, noting 'if we wait until we see long‑term inflation expectations rising in the surveys and the other ways that we try and measure it … it's too late'.
2.56In its May 2024 Second Interim Report, the committee called for the Labor Government to 'reduce its aggregate spending to support the RBA in its efforts to curb inflation'.
2.57The Labor Government has not yet responded to this recommendation, and in both its rhetoric and policy announcements shows no sign of heeding the committee's warning.
The Reserve Bank of Australia's response to inflation
2.58As noted above, the RBA's primary approach to implementing monetary policy is through varying the cash rate target. Interest rates are used to slow down demand relative to supply to rebalance the economy when inflation is above the RBA's target range of two to three per cent.
2.59In 2022 and 2023, the RBA Board voted to increase interest rates 13 times. At the time of this report tabling, there had been no changes to interest rates in 2024.
2.60The persistence, or 'stickiness', of Australia's inflation continues to be a major challenge for the Labor Government.
2.61The RBA, in its August 2024 Statement on Monetary Policy, was of the view that the 'slow progress on disinflation over the past year suggests that demand continues to exceed the capacity of the economy to supply goods and services, and by a little more so than previously thought'.
2.62As noted above, the RBA does not believe underlying inflation will be convincingly inside the target range of two to three per cent until late 2025, and will approach the midpoint of the band in 2026.
2.63For the year to September 2024, mortgage interest charges increased by 18.9 per cent. This represented a downward trend compared with a peak of 91.6 per cent in the June 2023 quarter for the previous year, largely reflecting the RBA's more recent decisions to keep interest rates on hold.
2.64However, since the RBA started its tightening cycle, the cash rate has increased by 400 basis points, costing the average Australian mortgage holder thousands.
The impact of interest rate increases
2.65Determining the overall impact of interest rate increases on Australians is not straightforward—around a third of Australians rent, around a third own their homes outright and about a third own their homes with a mortgage. In practice, this means that tighter monetary policy (i.e. interest rate increases) generally initially impacts home owners with a mortgage through higher interest costs and subsequently impacts renters if mortgage costs are passed on through higher rents.
2.66The RBA's decisions to tighten rates and keep them higher for longer is directly impacting Australian households. Data from the National Australia Bank indicates that both mortgage holders and renters are experiencing 'stress' because of historically high interest rates and inflation, a proposition that was supported in evidence to the committee from charities and not-for-profits and individuals.
2.67Anglicare Australia pointed to research suggesting that 31 per cent of households are now in mortgage stress, with 20 per cent facing extreme risk.
2.68The RBA correctly noted that high inflation is 'particularly challenging for those with lower incomes'. Further:
The longer it takes for inflation to return to target, the greater the cost of living pressures on households and the greater the risk that inflation and wage expectations drift higher. History shows that, should this occur, it would require more monetary policy tightening and a costly period of higher unemployment to stabilise inflation expectations and return inflation to target. At the same time, a sustained period below full employment can have long-lasting effects on those who lose their jobs or are unable to find work.
2.69In August 2024, the RBA provided the committee with arrears and mortgage burden data by region and state or territory to demonstrate the proportion of borrowers particularly impacted by the current cash rate. The Northern Territory (0.74 per cent), Victoria (0.67 per cent) and Western Australia (0.62 per cent) had the highest share of borrowers in 90-day arrears.
2.70Victoria had the highest share of borrowers with a high mortgage burden (12 per cent), followed by Tasmania (11.4 per cent) and Western Australia (10.6 per cent). A high repayment burden is defined as households in the lowest income quartile spending more than 30 per cent of their income on mortgage payments.
2.71The Australian Banking Association suggested in August 2024, that mortgage 'arrears remain lower than before the pandemic, as do repossessions', with 1.6 per cent of residential mortgage loans in arrears at the end of March 2024.
2.72However, arrears data does not show what proportion of mortgage holders have moved to interest-only mortgage payments. Evidence to the committee from charity groups suggested that mortgage repayments were the last thing Australians would go without, looking to reduce discretionary spending and then even necessities like food before their mortgage repayments. Media reports indicate that households may be choosing to default on other bills rather than their home loans.
2.73 A survey by Finder of 1062 respondents, published in July 2024, found that 21 per cent had shifted to interest-only loans in the past two years, with six per cent doing this to avoid falling behind on repayments. Finder extrapolated these findings to conclude that more than half a million people had shifted to interest-only repayments over the past two years alone, and almost 200 000 Australians were servicing interest-only loans to avoid falling behind in their mortgage repayments.
2.74More and more mortgage holders may be forced into a position where selling their home is the only viable option, with the number of homes that have been resold in the last three years increasing by 16 per cent, as of May 2024.
2.75Mr Warren Hogan suggested that the RBA's 'narrow path strategy' of keeping interest rates lower than other countries, or 'running inflation above target for an extended period of time', leaves Australia 'more vulnerable' to shocks to the economy 'than other nations that have less patience than we have for inflation and this cost of living crisis'.
2.76The impact of heightened interest rates has also had flow-on effects on the private and not-for-profit sectors. For example, the Australian Charities and Not-for-profits Commission's June 2024 Australian Charities Report—10th Edition highlighted that the cost of interest and other expenses—including rent, insurance, cost of goods sold and other costs—had increased by 52.4 per cent for charities compared with three years ago. This supports findings in the Second Interim Report that 'at the same time as meeting increased demand, charities have also been struggling with higher operational costs'.
The Labor Government's response to inflation
Fiscal Policy
2.77As noted in the First Interim Report's Finding 2, the 'most effective way to reduce inflation is to have monetary policy and fiscal policy working in the same direction'. Unfortunately, as outlined in the Second Interim Report, this has not been the experience in Australia under Labor.
2.78The Labor Government's policy response to inflation and the accompanying cost of living crisis has been wrongheaded, and Australians have paid the price for this. The Second Interim report noted:
As the economic plight of Australians has dramatically deteriorated over the past two years, it is clear there has been no effective plan to manage the spiralling costs faced by Australian households. Instead, the Government has pursued policies that has kept inflation higher for longer, and worked contrary to the RBA's management of economic settings to keep interest rates high.
2.79This position was echoed by senior public sector economists in the lead-up to the 2024–25 Budget, who called on the Government to reduce expenditure to take pressure off inflation.
2.80Chris Richardson of Rich Insights said:
If the government wants to do something about the cost of living, then more than anything else it wants something to be done about inflation … You can play around with the symptoms all you like but the cause here is inflation.
2.81Similarly, Jonathan Kearns, Chief Economist at Challenger noted that:
Monetary policy has been doing the heavy lifting, but having contractionary fiscal policy can spread the load. The tighter fiscal policy is, the sooner and faster interest rates can come down.
2.82Unfortunately, in the six months since the release of the Second Interim Report, the Labor Government has failed to change its approach, and instead continued its focus on temporary solutions focused on political outcomes, rather than effective measures.
2.83This was exemplified in the Government's 2024–25 Budget, delivered in May 2024.
2.84Following the 2023–24 Budget, the financial year ending June 2024 saw an increase in general government expenditure of 4.7 per cent, compared with 0.5 per cent for households. As noted above, general government expenditure contributed 0.3 per cent to GDP, while household consumption contributed ‑0.1 per cent.
2.85In the 2024–25 Budget, new policy decisions from the Labor Government will mean around $22.4 billion in government spending over the forward estimates. This will contribute to an aggregate additional expenditure of $315 billion since Labor came to government compared to the 2022 Pre-election Economic and Fiscal Outlook (PEFO).
2.86Dr Shane Oliver noted that 'in a world of high inflation, where you need to raise taxes or cut spending, that is politically unpopular and so governments don't do it'. Dr Oliver considered that 'the government should be cutting government spending' to reduce inflation. He argued:
… the economy will slow under the weight of high interest rates, but the RBA's job would be a lot easier if they didn't have the surge in government spending that has been occurring over the last few years. It's like two forces operating in different directions …
Governor Bullock [made a reference in August 2024] to demand being too strong. She actually said that's consumer and public spending. It's hard to say that's consumer because demand growth there is close to zero; I think it is more government. And when asked, 'Why have the forecasts gone up?' she specifically referred to, 'We've got some numbers on high government spending since the May meeting,' which was before the last budget and before the state budgets. There are other things in there as well. But I have a feeling that, if we had much lower growth in government spending, the Reserve Bank would either be considering cutting or much closer to cutting whereas … they are still considering hiking.
2.87Professor Richard Holden was of the view that 'the current government has handed down multiple highly expansionary budgets'. Professor Holden further argued that government 'fiscal policy, both state and federal, has been very expansionary and is putting upward pressure on inflation'.
2.88Similarly, Mr Warren Hogan suggested that the government sector (at all levels) comprises at least a quarter of the Australian economy. As such, if government spending:
… is rising at a pace more quickly than the capacity of the economy, which it is, at both the state and the federal level, then it will be adding to the demand pressures in our economy and adding to the inflation pressures in our economy.
2.89In its 2024–25 update on the fiscal outlook and sustainability, the Parliamentary Budget Office stated that over the long term, continued 'fiscal sustainability requires ongoing policy discipline'. Further, future 'considerations of tax reform will need to consider how to raise alternative sources of tax revenue, as well as how to target government spending to ensure the Budget's resilience and sustainability'.
2.90Dr Stephen Halmarick, Chief Economist at the Commonwealth Bank of Australia, summarised the impact of Labor's third Budget on inflation and the ability of the RBA to reduce rates, saying:
The risk is now more real the first interest rate cut could be delayed, and that the neutral cash rate is higher than we currently estimate due to the expansionary fiscal setting and the high level of investment in the economy.
2.91This appears to have been borne out, with the RBA deciding not to reduce rates at any meeting since the 2024–25 Budget, and Governor Michele Bullock telling the media following the August Board meeting that 'a rate cut is not on the agenda in the near-term'.
2.92This additional expenditure and fiscal pressure on inflation has added to expansionary pressure from state and territory governments. As noted by the International Monetary Fund (IMF):
State and Territory budgets have proven more expansionary than expected in the near-term, incorporating further cost-of-living support and infrastructure spending. Should disinflation stall, expenditure rationalization at all levels of government could help lower aggregate demand and support a faster return of inflation to target.
2.93The RBA also noted this, telling the committee in August 2024 that state 'governments accounted for around two-thirds of the additional spending announced in recent budgets, with the Australian Government accounting for the remainder'.
2.94Analysis has suggested the expansionary budgets pursued by state and territory governments have added to the fiscal pressure on total aggregate demand, with some analysis suggesting that 'state governments are recording some of the largest deficits in the developed world'.
2.95As noted above, in May 2023, the committee found that the 'most effective way to reduce inflation is to have monetary policy and fiscal policy working in the same direction'. In May 2024, the committee called for the Labor Government to 'reduce its aggregate spending to support the Reserve Bank of Australia in its efforts to curb inflation'.
2.96The committee also called for the Labor Government to 'legislate to deliver a lower, simpler and fairer tax system that fights bracket creep and enshrines aspiration in our tax system'.
2.97The Labor Government has not yet responded to these recommendations and has shown no inclination to alter its fiscal approach.
Energy subsidies
2.98The RBA was of the view that the largest government policy expected to have the most impact on headline inflation is the Labor Government's energy rebates (along with state government rebates), which the RBA anticipated would reduce headline inflation in the September quarter. However, the RBA further forecast that the unwinding of those policies would elevate headline inflation beginning from the September quarter 2025.
2.99Both the short- and medium-term effectiveness of these policies have been widely questioned by economists.
2.100In the short term, the reduction does little to reduce actual aggregate demand, as Australians may spend the money they would have otherwise paid in energy prices on other goods and services. In the medium term, the RBA's projections show inflation rising as soon as the rebates cease in 2025. As Dr Holden told the committee:
… whether you take $300 off people's energy bills or write them a cheque for $300, the effect is basically the same. Subsidies of any kind are stimulatory, and they put upward pressure on inflation. This claim that they're magically knocking 60 basis points off inflation is nothing more than a national accounting trick. The RBA has been incredibly clear that they see through that, and so the idea that there is some sort of new magic formula where we can spend government money and have it reduce inflation is a trick, and it's not fooling anybody.
2.101HSBC's Chief Economist Paul Bloxam stated that while the energy subsidy (combined with Labor's rent assistance increase) would 'mechanically' lower CPI:
… clearly the subsidies also boost real household disposable incomes—giving households more income to spend. Many households that receive these subsidies are also likely to be up against their budget constraints—due to cost of living pressures … We expect some of this additional income will be spent, supporting consumer demand and adding to inflation.
2.102Expert economists widely critiqued the payments in a similar vein, with KPMG Chief Economist Brendan Rynne describing the measures as 'smoke and mirrors' and Warwick McKibbin, economist and former RBA Board member calling the payments a 'political trick'. Carlos Cacho, economist at Jarden, similarly noted that, while 'the government argues that cost-of-living support measures such as energy and rent subsidies will bring down CPI, we fear they are likely to stoke broader inflation'.
2.103The IMF similarly noted in its analysis that 'while the cost-of-living support lowers the price level on a temporary basis, it may inject some additional stimulus into the broader economy'. It further noted that a 'a stronger-than-expected fiscal impulse' constituted a domestic risk that disinflation would stall.
2.104IFM Investors Chief Economist, Alex Joiner, noted that, following the release of the September 2024 quarter CPI, the 'fall in electricity costs without subsidies is modest at best, and should rebates end the impact on inflation to the upside will be material' (see Figure 2.6 below).
Figure 2.6Electricity rebates in the CPI, 2023–24
Source: Alex Joiner, post on X, 30 October 2024, x.com/IFM_Economist/status/1851431255356870695 (accessed 31 October 2024).
2.105As Michael Read of the Australian Financial Review observed:
Out-of-pocket electricity costs would have increased by 29 per cent nationally since June 2022 without state and federal government intervention, according to the Australian Bureau of Statistics. Bills have instead declined by 5.3 per cent on average due to the rebates.
2.106However, the temporary nature of these subsidies was highlighted in Read's analysis, which stated that, based on future price forecasts (from Westpac), out-of-pocket household electricity expenses could rise by almost 50 per cent on average nationally between October 2024 and September 2025 if all energy rebates ceased (see Figure 2.7).
Figure 2.7Household electricity bill price index, 2023–25
Source: Michael Read, 'Electricity bills to surge 47pc next year as government support ends', Australian Financial Review, 25 September 2024.
2.107Following the announcement of the energy payments, the RBA's Assistant Governor (Economic) Dr Sarah Hunter told the committee that the RBA was 'now looking and focusing quite closely on Trimmed mean inflation, as we know that headline inflation is going to be impacted by the government's energy rebates and other cost-of-living measures that were announced in federal and state budgets earlier this year'. This suggests that while it may lead to a shift in the data points by the Australian Bureau of Statistics, the Government's energy subsidies' impact on inflation was, at best, cosmetic.
2.108The RBA Governor highlighted the importance of the Trimmed mean measure, noting:
The Board needs to be confident that inflation is moving sustainably toward the target band before any decision about a reduction in interest rates. We really need to see progress on underlying inflation coming back down toward the target.
2.109The Governor was even more explicit in dismissing the effectiveness of the Labor Government's temporary subsidy of energy prices on inflation, noting:
So I think the point I would make is that if tomorrow we get an inflation number which has got a 2 in front of it so it's back in the band, that doesn't mean that we've got inflation under control. It doesn't mean that inflation is sustainably back within the band. It just means it's back there at the moment. So I think what I want to draw out with sustainably is that we need to see that there's a consistent trend down to the band and it's going to stay in the band rather than dip in and out.
2.110As noted above, the RBA's Statement of Monetary Policy released in August 2024 shows headline inflation falling to three per cent in December 2024 and 2.8 per cent in June 2025, before increasing again to 3.7 per cent in December 2025 and remaining above three per cent until December 2026.
Productivity
2.111Improving productivity is a key lever through which inflation can be reduced. Productivity refers to 'how much output can be produced with a given set of inputs'. Productivity increases 'when more output is produced with the same amount of inputs or when the same amount of output is produced with less inputs'. In short, productivity arises because of the interaction between capital and labour—or, the existing labour force making better use of technology to improve their output.
2.112As Dr Shane Oliver from AMP put to the committee, governments can reduce inflation to boost productivity:
But we also need measures to boost the efficiency of the economy: deregulation; make it easier for businesses to get production up to start producing things; tax reform; and competition reforms. There is a long list of this stuff. I don't think it is necessarily the role of government to start setting up petrol stations, but there is maybe a role for a tougher competition response … and obviously investment incentives ...
Really, the role of government in the first instance is to make life easier for the Reserve Bank—get government spending down—and, in the second instance, to focus on long-term productivity-enhancing reforms.
2.113Australia is primarily a services economy, like most other developed economies, with the services sector generating around 80 per cent of Australia's GDP and services industries employing 90 per cent of the workforce. There are significant challenges associated with measuring productivity in services industries and with achieving productivity gains.
2.114After the late 1980s, when productivity growth was around 3.0 per cent, productivity growth slowed to around 1.4 to 1.5 per cent through to the early 2000s. Australia's better economic performance during this period has been largely attributed to micro-economic and macro-economic reforms implemented by successive governments.
2.115According to the Productivity Commission, labour productivity for the whole economy fell by 3.7 per cent in 2022–23, because output growth failed to keep pace with a record increase in hours worked. Further, workers had access to less capital on average, which weighed down labour productivity.
2.116Growth in productivity is the main driver of long-term income growth. Although labour productivity fell in 2022–23, gross national income grew by 0.4 per cent, driven by increased labour utilisation as Australians worked more hours. The Productivity Commission was of the view that labour utilisation is unlikely to be a key driver of future income growth, because Australia was at near historical high levels of workforce participation at the end of 2022–23.
2.117The RBA outlined for the committee at the 7 August 2024 hearing, how events in the last few years may have impacted productivity:
The COVID run-up in the early years of the pandemic meant some relatively low productivity sectors around some of the hospitality services and things like that, which were under lockdown conditions. Those sectors weren't able to fully operate so we had a spike in productivity. We then re-opened the economy. That spike was unwound. Since then we've had productivity falling below pre COVID levels. Now we've seen a bit of a recovery over the last little while … It is very hard to read from that what is happening to the underlying trend and structural pace of productivity growth, which is why we look at a longer period to give us an anchor point for the forecast … [W]e expect it to get back to around one per cent.
2.118The Treasury noted that if productivity were to remain below its long-term, pre‑COVID trend level, this will see 'more pressure on businesses and costs, and that could flow through to inflation. But equally, if it comes back a bit quicker, then you'd see downward pressure on inflation'. Unfortunately for Australian businesses and consumers, there is little evidence that productivity is improving under this Labor Government.
2.119Multiple economists at the Sydney hearing in August 2024 expressed concern about Australia's productivity. For example, Dr Oliver noted that 'the pandemic seems to have allowed a permanently higher level of government spending as a share of the economy, which can have impacts on productivity through time, because you end up with a smaller private sector'. When asked how Australia could improve its productivity, economists made the following suggestions:
tax reform;
increased flexibility in the industrial relations system;
reducing regulation;
reducing Federal Government spending as a proportion of GDP;
improving education and training;
focusing Australia's migration program on skills;
upskilling of the workforce;
reskilling of the workforce to move within their current organisation;
ensuring that workers are the right fit for the jobs they are in;
improved business investment in equipment, software and organisational arrangements; and
reducing income tax.
2.120In 2012, the then Chair of the Productivity Commission, Gary Banks, provided a 'to-do' list of productivity policies to improve productivity. These included:
ending selective industry subsidies that cannot deliver demonstrable net social benefits; and
conducting rigorous evaluations of all government innovation programs.
2.121The Labor Government has not pursued these approaches, but instead appears to be doubling down on a programme of 'picking winners' through its Future Made in Australia policy (discussed further in Chapter 4).
2.122Mr Hogan suggested that the Productivity Commission could look at the role of the labour market in Australia's productivity and how the Australian economy has performed in the last decade, including through the pandemic. He argued that there 'is something … different between our economy and those overseas, and I think the labour market is very much at the core of it'. Mr Hogan also suggested the Productivity Commission could examine how to promote increased investment in Australia's business community, given business investment 'is shown in most economies to drive future productivity'—a conclusion supported by evidence presented in the Second Interim Report.
2.123Mr Stephen Walters, Chief Economist at the Business Council of Australia, argued that over the last 30 years, productivity across the construction sector has 'gone nowhere' despite 'productivity in the rest of the economy' expanding 'quite substantially'. Professor Holden proposed that the Productivity Commission be tasked with examining 'what's happened to productivity in the building sector over the last several years and what's happened to costs', given ongoing issues in Australia with the construction sector are impacting housing costs and the economy more broadly.
2.124Industry representatives supported potential policies to improve productivity. For example, Ms Tanya Barden from the Australian Food and Grocery Council stated that she 'would welcome a productivity agenda … I think that changes we've seen in industrial relations haven't been coupled with a productivity agenda'. In addition, Dr Jeffrey Wilson from the Australian Industry Group suggested that labour 'hire and the industrial relations agenda are … moving … in the opposite direction to where the productivity agenda needs to go'. For a discussion of the impact of higher energy prices of the last two and a half years on productivity, see Chapter 3.
2.125In May 2024, the committee made multiple recommendations to the Labor Government intended to improve productivity. These included:
carrying out a stocktake of Commonwealth regulation relating to small-to-medium enterprises, with a view to reducing the 'costs of doing business' that have exacerbated the cost of living crisis;
repealing business-harming industrial relations policies, particularly for small-to-medium sized businesses, and focusing on delivery of a more flexible and more productive workplace;
removing the heavy vehicle charge increases introduced in the 2023–24 Budget;
removing the Biosecurity Levy increases introduced in the 2023–24 Budget; and
removing arbitrary price controls from interventions that have the impact of discouraging the investment that will deliver greater supply and lower energy prices for individuals and businesses.
2.126The Labor Government is yet to respond to these recommendations.
2.127Given the immensity of the challenge to improve Australia's productivity, and the dispersed nature of the relevant policy levers across jurisdictions, there is a need for greater coordination, particularly between Commonwealth and state and territory governments. As such, a continuing forum or specific agenda item for National Cabinet should be considered. The committee's recommendations on this matter are set out in Chapter 5.
International conditions and the Australian economy
2.128International conditions provide a useful comparison for the state of Australia's cost of living crisis, and the effectiveness of the Government's response to it, particularly as other developed economies have experienced similar economic circumstances following the COVID-19 outbreak.
2.129In its World Economic Outlook Update of July 2024, the IMF projected global economic growth of 3.2 per cent in 2024 and 3.3 per cent in 2025. The IMF noted that globally, services 'price inflation is holding up progress on disinflation', which in turn is complicating the normalisation of monetary policy. As a result, upside 'risks to inflation have thus increased, raising the prospect of higher-for-even-longer interest rates'. In particular, the IMF highlighted slowing momentum on global disinflation, 'signalling bumps along the path', and flagged that 'fiscal discipline … in some countries is … strained by the inability to rein in spending or raise taxes'.
2.130As of September 2024, multiple developed countries had already begun to cut interest rates, including the United States, the United Kingdom, Canada, New Zealand, Sweden and the European Union, along with China. The Governor of the RBA explained in August 2024, that overseas interest rate movements (particularly in the United States) may impact inflation in Australia:
… [I]f the interest rates in the US start to decline, which people are expecting, that will probably give a bit more support to our exchange rate ... The exchange rate … impact[s] particularly exporters, so as the exchange rate declines it's good for exporters that are selling in US dollars because they get more income, and when the exchange rate appreciates, as you note, that's more difficult for exporters, but the exchange rate does play a role in helping to keep inflation in the band as well. So, when we put up interest rates normally, if no-one else was moving interest rates, that would put a bit of upward pressure on our exchange rate, that would mean that imports would be a bit cheaper, exports would be a bit more expensive, and that would help to lower inflation. At the moment, everyone had increased their interest rates coming out of the pandemic so we didn't really get much action from the exchange rate. But over the next while, as different countries go different ways, it is going to come back into play.
2.131In evidence at the 16 August 2024 hearing, the Treasury noted that Australian inflation places Australia roughly in 'the middle of the pack … or even at the lower end of that compared to some of the key G7 countries that we look at'. Further, Australia's peak inflation was 'lower than some other countries, but it was somewhat later … [W]e may in some cases be just lagging other countries' experiences by a few months or a quarter as we come down … Every country is at slightly different stages now in terms of both its inflation cycle and its monetary policy cycle'.
2.132However, this characterisation of 'middle of the pack' is not reflected in international comparison data. For example, the IMF advanced economies inflation forecasts, released in later October 2024, suggested that Australian inflation would be the highest of 40 comparable countries save only the Slovak Republic. The IMF's data suggest that by 2025, headline inflation would still be 3.6 per cent, almost an entire percentage point above the next highest country, Slovenia (see Figure 2.8).
Figure 2.8IMF advanced economy inflation forecasts: Year-ended headline inflation 2024–25
Source: adapted from John Kehoe and Michael Read, 'Australia a laggard in the global battle to beat inflation', Australian Financial Review, 23 October 2024.
2.133Australia's position compared to like nations was further highlighted in analysis following the September 2024 quarter CPI release, which showed the Trimmed mean inflation (also known as 'underlying' or 'core') inflation remained relatively high at 3.5 per cent (see Figure 2.9).
Figure 2.9Selected country "core" inflation
Source: Alex Joiner, post on X, 'Selected country “core” inflation', 30 October 2024, x.com/ifm_economist/status/1851435127009931774?t=9x1hevoC-igksntkSVT1yw (accessed 31 October 2024).