Can Australia Reduce Inflation Without Increasing Unemployment?
- Written by: The Times
When Australians hear that the Reserve Bank believes unemployment may need to rise to bring inflation under control, many ask the same question.
How can putting more people out of work possibly improve the economy?
At first glance, it seems completely counter-intuitive.
After all, people without jobs spend less. Businesses sell fewer goods. Government welfare payments increase while income tax collections fall. Communities suffer.
Yet central banks around the world have long argued that an economy running too "hot" can generate persistent inflation.
When unemployment is very low, employers compete aggressively for workers. Wages rise more quickly, businesses face higher costs and many pass those costs on through higher prices. Consumers continue spending because employment remains strong, allowing inflation to become embedded across the economy.
The Reserve Bank's task is to prevent that cycle from becoming permanent.
Australia's inflation remains above the RBA's preferred 2 to 3 per cent target range, despite higher interest rates and slower household spending. While fuel prices linked to Middle East tensions have added to inflation, the Bank also believes domestic demand has remained stronger than desirable.
That leaves policymakers facing one of economics' most difficult trade-offs.
Higher interest rates slow borrowing, reduce discretionary spending and cool business investment. As economic activity eases, hiring generally slows and unemployment may gradually increase.
The hope is that inflation falls before unemployment rises significantly.
Whether that balance can be achieved is uncertain.
History shows that central banks rarely set out to create unemployment. Their objective is price stability because persistent inflation can damage living standards just as severely as recession. High inflation erodes wages, discourages investment and makes long-term financial planning difficult for households and businesses alike.
The question for Australia is whether inflation today is being driven mainly by excessive consumer demand or by factors such as global energy prices, housing shortages, insurance costs and supply disruptions.
If much of today's inflation originates outside Australia's borders, higher interest rates and weaker employment may have only a limited effect while imposing real costs on Australian families.
The Reserve Bank recognises this dilemma. It has left the cash rate unchanged while continuing to warn that inflation remains too high and that further action remains possible if necessary.
Australians therefore face an uncomfortable reality.
Inflation must return to sustainable levels if living standards are to improve over the long term. But every policy designed to cool inflation carries costs of its own.
The challenge for policymakers is not simply reducing inflation.
It is reducing inflation while preserving as many Australian jobs as possible.
