One of my children bought a new home in Melbourne the week before the COVID pandemic struck in February 2020. House prices plunged over the following three months, and he worried he had entered the housing market at the wrong time.
When there was a quick rebound in property values later in the year, he was very relieved but still angry that his generation had to pay so much for housing, compared with what we Baby Boomers had paid.
Yes, we built a house for $50,000 in 1975. But, given our income of $13,000pa at the time, this seemed to be an astronomical sum to pay for a home. Moreover, our financial position worsened over the following years because interest rates were increased to control higher inflation. This had been triggered by worldwide oil price shocks and supply shortages. Seem familiar?
Our housing loan interest rate climbed from 8 per cent in 1975 to 17.5 per cent in 1990. At the time, we were raising a family of six children.
Although current home buyers are paying very high house prices, the recent COVID emergency delivered payment relief for them via record low-interest rates. The official cash rate bottomed out at an emergency low of 0.1 per cent. This is the lowest interest rate recorded worldwide in the past 5000 years!
Rapid inflation is bad for the economy and the people.
The Reserve Bank governor, Philip Lowe, promised in 2021 that there would be no increases in interest rates until 2024. However, worldwide events such as the war in Ukraine, energy, and other COVID-induced supply chain shortages, have conspired in the early 2020s to again unleash the inflation genie from the Australian economic bottle. As a result, it is now well beyond the Reserve Bank's 2 to 3 per cent target range.
Inflation is like Goldilocks' porridge. It is 'just right' if neither too hot nor too cold. Warm inflation porridge is usually in the 2 to 3 per cent band, and for the past 30 years, this has been the Reserve Bank's target. The current situation is that inflation has rapidly jumped from under 2 per cent to over 5 per cent in a few months, and is possibly heading as high as 7 per cent. So, the Reserve Bank has needed to act fast, to try to head off the inflation surge created by the rapid rise in the price of goods and services.
Rapid inflation is bad for the economy and the people. It erodes the actual value of savings and purchasing power. It disproportionately hurts low-income consumers who spend much of their income on necessities. The expectation of future inflationary price rises leads to workers demanding more significant wage increases, and employers pass on these costs as higher prices, setting off a wage-price upward spiral.
This occurred in the early 1980s under the Fraser government. The-then centralised wage fixing system, adjudicated by the Australian Conciliation and Arbitration Commission (ACAC), for a time, awarded wage rises every three months to compensate for recent price rises, so the upward spiral continued.
The primary economic tool governments use to fight inflation is monetary policy, notably higher interest rates. The result is that inflation and interest rates move in the same direction - currently upward. Recently the COVID 0.1 per cent RBA benchmark cash rate has been increased monthly, with three rises taking it up to 1.35 per cent, so far in 2022.
The effect of just one of these recent monthly rises of 0.5 per cent interest on a family with a $750,000 mortgage has been an increase in monthly home loan repayments of $200 a month. People who believed the Reserve Bank's long-term interest rate prediction have been caught out if they bought a new home recently.
Although using interest rates to control high inflation negatively affects household budgets and the viability of some businesses, the government must get inflation back into the target band range ASAP. If they fail, high inflation could result in another recession.
The last time this happened was in the Keating "recession we had to have", in the early 1990s. Then, economic growth plunged, businesses failed, and unemployment rose rapidly, remaining high for years.
If this happens again in the 2020s, the damage to the Australian economy will be considerable and long-lasting. Small businesses, the workforce, and consumers (particularly those on lower incomes) will be badly affected.
As a nation, we haven't experienced a recession for 30 years.
It will take excellent economic management and good luck in the 2020s to tame the inflation dragon again and continue Australia's record-breaking run of avoiding recession.
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