The Reserve Bank is tipped to increase interest rates tomorrow because of an ongoing concern that inflation is not under control.
asserted
inflation → tip → control
In the past week, much commentary has focused on whether government spending cuts could be a "precise instrument", taking pressure off inflation in a targeted way and alleviating the pain of high rates.
uncertain
cuts → focus → rates
The government has flagged at least some fresh savings.
asserted
government → flag → savings
So where could cuts come from, and could they influence inflation?
uncertain
they → come → inflation
How inflation happens
In simple terms, inflation happens when an economy is operating above capacity.
asserted
economy → happen → capacity
When the demand to spend is more than what an economy can supply, the extra demand pushes prices up.
asserted
demand → spend → prices
The cause can come from anywhere.
asserted
cause → come → ?
The Reserve Bank thinks the resurgence of inflation in the past year has been driven by the Middle East war, an AI investment boom, and the fact Australia was already above capacity before those things.
asserted
Australia → think → things
Whatever its origins, economists worry about inflation becoming entrenched in an economy.
asserted
inflation → worry → economy
RBA governor Michele Bullock explains it this way:
"High inflation hurts all Australians, especially the most vulnerable.
asserted
inflation → explain → Australians
Every household has seen how the price of everything has gone up in recent years.
asserted
price → see → years
Pay packets don't go as far as they used to …
asserted
they → go → ?
"It's critical that we stop [this] from becoming embedded in price-setting decisions across the economy or the problem will only become worse."
asserted
problem → stop → economy
How interest rates work
Policies to fight inflation can seek either to expand supply or suppress demand.
asserted
Policies → work → demand
While supply policies are important, demand suppression works quicker, and so is the main frontline response.
asserted
response → work → ?
The aim is not to address the causes of inflation or to lower specific prices.
asserted
aim → address → prices
For example, policymakers can do little about high fuel prices.
asserted
policymakers → do → prices
Instead, they aim to take pressure off elsewhere as a counterweight.
asserted
they → aim → counterweight
The Reserve Bank has one main lever: higher interest rates.
asserted
Bank → have → lever
High rates suppress demand in multiple ways.
asserted
rates → suppress → ways
Existing borrowers — people and businesses — pay more on their loans, leaving less money to spend elsewhere.
asserted
borrowers → exist → money
New borrowing is discouraged.
asserted
borrowing → discourage → ?
Saving is encouraged, because the returns are higher.
asserted
returns → save → ?
And Australian dollars become more expensive, pushing down overseas demand for our exports.
asserted
dollars → become → exports
How government spending can help or hinder
The government's main lever is its budget.
asserted
lever → help → ?
Every year, the government raises and spends hundreds of billions of dollars.
asserted
government → raise → dollars
Taxing more or spending less can directly reduce demand.
asserted
Taxing → tax → demand
This can be a precise instrument because the government can choose exactly what programs it cuts, or exactly where it raises taxes.
asserted
it → choose → taxes
In theory, it means the government can fight inflation with regard for "fairness" in a way that the Reserve Bank cannot, because it can decide who should bear the brunt of the pain.
asserted
who → mean → pain
But inflicting pain with higher taxes or spending cuts is politically fraught.
asserted
inflicting → inflict → taxes
And in fact, governments are often pulled in the other direction.
asserted
governments → pull → direction
When prices are high, voters expect relief in the form of tax cuts or subsidies.
asserted
voters → expect → cuts
Governments often oblige, even though this can push up inflation by expanding demand rather than suppressing it.
asserted
this → oblige → it
The Albanese government has made a virtue of offering this sort of cost-of-living relief, and despite its criticisms, the Coalition has advocated for relief too.
asserted
Coalition → make → relief
Treasurer Jim Chalmers argues this is justified, because the government has multiple roles:
asserted
government → argue → roles
"We have to balance the inflationary pressures in our economy with the fiscal pressures in our budget and try to do the best that we can for people…
asserted
we → have → people
We think we've struck [the balance] relatively effectively.
asserted
we → think → balance
How much has the Albanese government spent?
asserted
government → spend → much
There are several ways to assess how the government has struck that balance.
asserted
government → be → balance
One is to look at the overall level of spending.
asserted
One → look → spending
…and 23 more, not listed.
The Aporia
