The inflation statistics that were made public last week corroborate what we already knew: rising gasoline prices are the main cause of inflation.
The March numbers demonstrate that none of the inflation has passed through to other sections of the economy. Automotive fuels alone accounted for an astounding 90% of the monthly rise. In fact, annual headline inflation would have been lower than the previous month if vehicle fuels had not gone up.
The trimmed mean, an indicator of underlying inflation provided by the Australian Bureau of Statistics, supported this. At 3.3%, it remained constant from the prior month. For the last four months, the trimmed mean has remained constant at 3.3%.
However, why is this significant?
It is crucial because we must identify the factors contributing the price increases. Raising interest rates can assist reduce inflation if price increases are brought on by excessive demand.
However, interest rates have no influence on reducing inflation if the price increase is brought on by a supply shock.
The data is clear The increase in inflation is from a supply shock Demand is not driving any of it, and raising loan rates will only cause Australian households more unnecessary suffering.
Increases in interest rates respond to demand. People have less money to spend on other things if they are making larger mortgage payments. Businesses will have to compete more fiercely to sell everything if there is less demand. They will be less inclined to raise prices in this setting.
However, higher interest rates will not help lower fuel prices if that is what is causing the inflation. The Strait of Hormuz will remain closed regardless of how high Australian interest rates rise.
Reduced household demand is another effect of rising fuel prices. People will have less money for everything else if they are spending more on fuel. Reduced expenditure results in slower economic expansion.
Spending and economic growth will be further slowed if interest rates rise in addition to rising fuel prices. At that point, the economy runs the risk of stagnating and perhaps going into a recession.
The market believed that an increase in interest rates was somewhat less likely following the release of the most recent inflation data. However, there is still a 75% possibility that rates will rise.
Even while the evidence suggests that the Reserve Bank of Australia should not raise rates this week, there is a good possibility that it will.
The RBA believes that it is the only institution that must combat inflation. It worries that if it does nothing, people would think it is not taking the fight against inflation seriously. Therefore, even though it will not solve the issue, it might pull the interest rate trigger instead of acting morally.
The twisted reasoning is that it is preferable to appear to be doing action, even if it exacerbates the issue, than to acknowledge that it is ineffective.
It will justify increasing interest rates by saying that it need to prevent inflationary expectations. People will seek higher wages to offset rising prices if they believe inflation will remain high. If they are successful in obtaining higher wages, businesses' production costs will rise, and they may raise prices, contributing to inflation.
That line of reasoning has a lot of ifs. The most significant is the notion that employees can simply demand better pay if they so want. For almost ten years, workers have fought for pay raises.
The main issue, however, is the lack of proof that inflationary expectations have risen. Even if inflation is connected to a foreign event that could end at any time, the RBA is simply assuming that they have increased because inflation has increased.
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