Yesterday (November 30, 2022), the Australian Bureau of Statistics released the latest—— Monthly Consumer Price Index Indicator – This is a new data series introduced by the ABS to augment the release of the quarterly CPI index. Regular readers will know that I view inflation during this period as transitory, meaning that it may dissipate quickly once the drivers fade. That doesn’t mean these drivers are necessarily short-term. They might stick with it. But the important point is that second-round transmission mechanisms such as wage price distribution battles do not exist as they did in the 1970s, which is why this event took on a life of its own once the initial oil price supply shock adjusted. Another important aspect of my assessment is that the current period of inflation does not indicate excessive fiscal support or justify central bank rate hikes. Current drivers are supply-side (pandemic, long-term Covid, OPEC+ and Ukraine situation), insensitive to interest rate changes. I get a lot of criticism for holding this view. Modern Monetary Theory (MMT) is the dead crowd who keep emailing me or trying to post scathing comments on this blog, telling me to take another life or end the one I have. The problem for them is that the latest data from around the world tells me that inflation is peaking during this period as supply drivers start to weaken.
Eurostat data shows European inflation has peaked
The latest lightning forecast data from Eurostat – Eurozone annual inflation falls to 10.0% (Published November 30, 2022) – Indicates that:
1. “The annual inflation rate in the euro area is expected to be 10.0% in November 2022, down from 10.6% in October.”
2. “From the perspective of the main components of inflation in the euro zone, energy is expected to have the highest annual rate in November (34.9%, compared to 41.5% in October), followed by food, alcohol and tobacco (13.6%, compared to 13.1% in October), non- Energy Industrial Goods (6.1%, stable from October) and Services (4.2%, from 4.3% in October).”
3. Belgium 10.5% (down from 13.1% in October); Germany down from 11.6 to 11.3; Greece down from 9.5 to 9; Spain down from 7.3 to 6.6; Italy down from 12.6 to 12.5; 16.8 down to 11.2; Austria 11.1 down from 11.5 etc.
It looks like supply drivers have weakened.
Australian inflation also appears to have peaked
I am cautious in saying peak because the current flooding in NSW that is affecting food production is likely to still cause further price pressure in the coming months before recovery is likely.
But that doesn’t change the assessment that this is a supply-side phenomenon, and changes in interest rates won’t bring lettuce and carrots back to growth any faster.
The latest figures from the Australian Bureau of Statistics show that the CPI across all categories increased by 6.9% in the 12 months to October 2022 after rising by 7.3% in the 12 months to September 2022.
However, the monthly CPI inflation rate for October 2022 was 0.17%, down from 0.61%, the lowest reading since April 2022 and February 2021.
The chart below shows the annual and monthly CPI inflation rates (respectively).
Clearly, despite the recent outlier in April 2022, the latest monthly estimates differ from previous months.
We can express this situation in a number of ways when we talk about inflation.
1. We can talk about the annualized inflation rate over the last 12 months, which is 6.9% and falling.
2. We can discuss the annualized quarterly rate – given that Australia’s CPI is traditionally released at this frequency – so we multiply the quarterly rate by 4. This figure for October 2022 will drop from 5.64% in October 2022 4.21% September.
3. We can talk about annualized monthly rates – so we multiply the current monthly rate by 12. By October 2022, that figure is 2.1%, down from 7.34%.
The interpretation of which is a better indicator of the current situation is influenced by the time series trend.
Clearly the trend is down, and the latest monthly estimates may represent where the series is headed.
This means that Australia’s inflation problems are quickly passing.
Is this the result of RBA rate hikes?
the answer is negative!
We can reach this conclusion by examining the components that make up the CPI results for all groups.
ABS Press Release (30 November 2022) – Monthly CPI indicator rises 6.9% in 12 months to October 2022 – point out:
Every year, the ABS updates the spending weights applied to the CPI basket…this is important to ensure that the CPI basket is up to date and representative of households’ current spending…usually, updating the weights every year has limited impact on the overall CPI. However, major changes in spending patterns in 2021 and 2022 this year mean that the reweighting has a bigger impact on the CPI than usual. The annual change in the monthly CPI measure for October was 7.1% using the previous weights, compared to 6.9% using the new weights.
Therefore, we always have to recognize that these data are statistical artefacts, and if the underlying methodology changes, the estimates will change even if nothing substantial actually changes.
When we drill down into the components of the All Groups CPI results, we find that:
1. Auto fuel prices rose 11.8% in October from 10.1% in September. This is entirely due to the federal government’s decision to end subsidies provided through the moratorium on fuel excise duties.
But the underlying trend is down as world oil prices fall.
2. Fruit and vegetable prices rose rapidly, falling from 17.4% in September to 9.4% in October due to flooding and transportation costs.
This is an example of how quickly things can change when temporary supply disruptions ease.
3. Construction costs rose 0.4% from 20% in September, mainly due to shortages of labor and materials.
The timber shortage can be traced back to the devastation caused by the huge bushfires before the pandemic and the situation in Ukraine.
There are other material shortages due to Covid disruptions in China and elsewhere.
4. Over the year to October 2022, headline housing inflation rose to 10.5% from 10.3% in September. Thus, rate hikes will not help calm the industry.
The chart below shows the annualized rates for the major components of the All Groups CPI.
As you can see, most component groups are trending down.
What about the impact of fiscal policy?
One of the purposes of fiscal policy is to ensure that spending is sufficient to create sufficient demand in the economy consistent with full employment.
Unemployment in Australia is relatively low at the moment, but we cannot yet say we are at full employment because the overall underutilization rate is higher than the SSDS% (the sum of unemployment and underemployment).
The main reason why the unemployment rate is so low is that the external borders were closed at the beginning of the epidemic, and immigration has not yet fully recovered.
Once the working-age population returns to its previous rate of growth, unemployment will rise slightly unless aggregate demand increases.
But we can assess whether fiscal policy is “overstimulating” the economy by looking at wages.
The prevailing view on the link between inflation and unemployment is that when the unemployment rate reaches the so-called non-accelerating inflation rate of unemployment (NAIRU), wage pressures built at that rate are likely to be in line with productivity growth, so that unit costs remain constant and inflation Stablize.
The prevailing narrative would then say that fiscal policy overstimulates the economy if the unemployment rate is below the unobserved NAIRU.
While NAIRU is unobserved, according to the story, the manifestation of overstimulation would be that excessive wage pressure outpaces productivity growth and pushes up unit costs, which are then passed on to higher prices.
So, even within that narrative space, if wage growth is weak and the wage share falls (meaning that real wages are outpaced by productivity growth), then it’s hard to say that unemployment is “too low” and lower than Naru.
Of course, I don’t believe the NAIRU story at all.
But the fact that wage growth is low and certainly not driving this inflationary event and that real unit labor costs are falling (as evidenced by the falling wage share) tells me that fiscal policy is not overly stimulating the demand side.
Unemployment is relatively low, but not low enough to create inflationary pressures in the labor market.
I stand by my earlier assessment in 2021 that this is transitory inflation and that inflation will subside as the various drivers weaken.
There is no structure propagation.
Enough for today!
(c) Copyright 2022 William Mitchell. all rights reserved.