Tag Archives: inflation

Energy Bill Relief and the Inflation Dragon: A Fairy Tale?

Last week the official inflation data came in higher than expected with a 1% rise in the Consumer Price Index (CPI) for the March Quarter (up from 0.6% for the previous quarter). That led to much commentary that it was the end to hopes for a cut in interest rates later this year. Apparently the inflation dragon is yet to be slayed, and, as noted in an earlier post, despite an alleged broadening of its focus, the Reserve Bank still aims its sole and somewhat blunt weapon first and foremost at the dragon.

The concern about the inflation dragon also flows through to the upcoming federal budget. The government is under significant pressure to provide cost of living relief, but its options are limited by the need to avoid contributing to further inflation by spending money or enabling more household expenditure. This is all premised on standard monetary macroeconomics which sees increasing money supply leading to increased demand and (absent proportionate production increases) to inflation.

But since neoliberal economics has seen governments of both political stripes outsource monetary policy (to the RBA), abandon fiscal policy (because higher taxes are bad) and largely ignore direct price controls[1] as means of constraining demand and inflation, how can the government help households without being economically irresponsible?

The Quest

The answer appears to lie in a magical quest to slay the inflation dragon (or at least control it) with a new weapon of “non-inflationary” spending. And in this quest, the government is aided by the good folk at the Australian Bureau of Statistics (ABS) who produce inflation data and some lazy economists who think that the data (the CPI) is the actual thing (inflation). Marx would probably call this data fetishism, but in a post-structural twist on ye olde dragon tale, the quest morphs into slaying not the inflation dragon, but its signifier – the CPI.

Image of the CPI header from the ABS website - but no mention of an inflation dragon.

How does this work and why is it important?

Let’s consider the Energy Bill Relief package announced in the last Federal Budget. It is a prime exemplar of this non-inflationary spending.

In the face of sky-rocketing energy prices, the federal government spent some $1.5bn (matched by state and territory governments) to provide a rebate on electricity bills for low-income households and small businesses. Without the rebate, the ABS estimates that electricity prices would have gone up by 17% since June 2023, rather than the 3.9% increase measured in the CPI. (This is because the CPI measures changes in the prices paid by households, so the government subsidy reduces that price – even if the actual price charged by the energy company has still gone up by the higher amount).

Sidenote: a similar calculation applies to the 15% increase in Commonwealth Rent Assistance in the last budget (totalling $540m this year) which took 1.7 percent points off what would have otherwise been a 9.5% increase in CPI for rent over the last year.

These policies provided welcome relief for low-income households struggling to pay for essential items, and as the data shows, they brought inflation down.

But this is just a mirage. Let’s consider what happens in the real world not defined by CPI.

Electricity Bill Relief v the Inflation Dragon

Ignore for a moment the problem that (at this stage) the energy bill relief is temporary, so electricity prices in the CPI will rise when it runs out. But remember that the package was introduced in the face of massive predicted energy bill increases. So, if a household’s electricity bill was $1,000 (to keep the maths simple) in June 2023, according to the CPI the household would now be paying $1,039 instead of the $1,170 that would apply without the rebate. There is still a cost increase to the household (inflation), but just looking at the bill, the government expenditure has at least constrained the dragon rather than fuelling its inflationary fire.

However, the analysis gets a bit trickier when we look at the household budget more broadly. Without the rebate the energy bill would be higher, but for many low-income households with no spare capacity in their budgets, a substantial rise in electricity prices is paid for by decreasing other consumption (often food because it is a more flexible expenditure). In that case, the total household expenditure is unchanged and the absence of the rebate does not increase demand or inflationary pressure in the economy – it is just shifts demand from food to electricity. In that context, the energy bill rebate is a good social policy (because the household can afford food), but it would have no impact on the inflationary pressure generated by household demand.  

That said, some households who received the energy bill rebate would have some savings or savings capacity (not least because the relief was poorly targeted). The increased cost of electricity could be met by those savings, or simply spending more and saving less in the budget. Either way, the total household expenditure would increase, and as this money flowed into the economy, it would increase demand and inflation.

While the energy bill rebate appears to lower inflation when we just look at the electricity bill (as the CPI does), when we look at the household more broadly it may have little impact or may fuel inflationary pressures.

The Macro-economy and the Inflation Dragon

But dragons fly higher than houses and it is only at the macro level that we see the inflationary impacts plainly. While in the above example, the household electricity bill went up by $39, the actual bill still went up by $170 and that extra money was paid – by the government. That money ($3bn in total) is out there in the economy. It initially goes to the energy companies, then to suppliers, workers and shareholders and is multiplied through their additional income and expenditure (with leakages for savings and overseas ownership).

All other things being equal (i.e. unless the government taxes back the energy bill relief expenditure, or it cuts spending elsewhere), this is just $3bn that governments are pumping into the economy and in standard economics that adds to demand and potentially to inflation. It is not magically non-inflationary simply because it is invisible in the CPI (which was not designed to capture it).

Just because you can’t see the dragon does not mean that the economy around you is not heating up!

Conclusion

None of this is to say that the Energy Bill Relief rebate (or the increase in rent assistance) were bad policies. They were not bad (notwithstanding the poor targeting of the energy bill relief, and the eligibility restrictions for CRA). Both measures provided much-needed support for people and households in need – I am just unconvinced that they would not add to inflation pressures.

If there is a magic trick to be had in this tale of the inflation dragon, it is not in the designation of some government expenditure as non-inflationary or imagining that restricting CPI is the same as controlling inflation. The real magic is probably in questioning the economic theory of the relationship between money supply, demand and inflation. There are some examples of this (in MMT and in the analysis of profit-led inflation), but that is a story for another day.

[1]              The exception here was the Federal government temporary cap on gas prices, but beyond that, there is no political will for such a controls – witness state and federal governments running a mile from rent freezes or even capping rent increases.

Inflation – what to do depends on your starting point

I have a T-shirt that I am wearing as I type this. On its front, in mock Gothic text are the words:

The wealth of those societies in which the capitalist mode of production prevails, presents itself as “an immense accumulation of commodities,” its unit being a single commodity. Our investigation must therefore begin with the analysis of a commodity.

These are the opening words of Marx’s epic work, Capital. As openings go, it is not as memorable as “In the beginning God created the heavens and earth” (Genesis), or “Man is born free, but everywhere is in chains” (Rousseau), or even Marx’s own “There is a spectre haunting Europe”.

However, it was only after reading Anwar Shaikh’s Capitalism and listening to his lectures that I realised the importance of this opening to Capital.

T-shirt with the opening words of Marx's Des Capital.

Comparing starting points

Marx’s words here are a recognition that to analyse capitalism we must start with the production of commodities, and their expression/capture of value. In capitalism, production does not happen as a charitable act or even as a provisioning of society in response to demand for goods and services (because we know that many people are not provisioned and some demand for necessities is unmet). Rather, production is organised and happens in the expectation of profit. From this starting point comes an analysis of:

  • how the production process is structured and contested,
  • the extraction of value beyond the cost of inputs into that production process, and
  • how this surplus is shared through the community – initially the distribution between capital and labour, but subsequently through flows to different parts of capital (e.g. financiers, technology owners) and finally through tax and transfers to different parts of the economy and society.

By contrast, much mainstream economics tends to start from exchange in a market – the price at the meeting of supply and demand. The production process is almost assumed (at least in the first instance). The return to capital is naturalised at an equilibrium rate determined by the market, while at the macrolevel, equilibrium can be obtained (or at least approached) by management of supply and demand – because what governs the economy is not a pursuit of profit but a market whose “natural state” is equilibrium.[1]

At one level, the different starting points mean that we are simply asking different questions and one may choose a theory depending on what question you want answered. However, it is more complicated than that, partly because the above is over-simplified, but also because, as I argued long ago, such theoretical starting points do not just ask different questions, they actually create different objects of inquiry – “the economy” is a different animal in the different theories.

But beyond that, the different starting points may have very different policy outcomes. Take for instance our current problem of persistent inflation.

Inflation

Regardless of the external factors that may have kicked off inflation (e.g. COVID, war, energy shocks), if your economic starting point is a supply and demand equilibrium, you are likely to see the need to reduce demand in the economy to ensure that demand is not exceeding supply and thus pushing up prices. At the most basic level, reducing demand at the macroeconomic demand can be done by:

  • fiscal policy, that is, increasing taxes to take money out of households and business, thus reducing their demand for goods and services), or
  • monetary policy – that is, increasing interest rates which in theory will increase savings (or loan repayments), similarly meaning there is less money to demand goods and services.

Fiscal policy is regarded as dangerous, partly because neoliberalism has convinced us that taxation is bad (and even undemocratic) and partly because surpluses lead to political pressures to cut taxes or spend more – which would be inflationary. So, we are left with the Reserve Bank increasing interest rates to try to dampen demand and bring inflation back to its target zone (2-3% p.a.)

However, if you start your economic analysis not from a theory of equilibrium supply and demand, but rather from a theory of capitalism and flows of value in an economy, then firstly, you might question the possibility of macroeconomic control by demand-management – as Shaikh does. Secondly, you might want to trace the impact of interest rates on flows in the real economy, where higher interest rates represent a bigger claim on surplus by finance capital. In this analysis, those seeking to make money out of non-finance capital are forced, to the extent possible, to increase their prices to maintain their return on capital.

This is most evident in the housing market where rental prices are increasing faster than inflation (September Quarter 2023 CPI: 5.4%, rent increases 7.6%). Higher interest rates increases costs and lowers the return to landlords with mortgages. They then put up rents to cover their increased costs, while landlords without mortgages can cash in on the higher rents attainable in the market. In this scenario, interest rates are driving rental inflation. Further, as the ABS has highlighted, rent increases are one of the major contributors to overall inflation. This is not to deny that there are supply problems in the rental market, but it does suggest that increasing interest rates may have a contradictory inflationary impacts.

Similarly, the conventional wisdom of higher interest rates taking money and demand out of the economy is challenged by the fact that around one-third of Australian households are not paying a mortgages or rent. For many of those households, higher interest rates translates as increased income from their savings. They have more money to spend and there is a growing recognition that this is promoting demand in those groups and undermining the demand-reducing purpose of increasing interest rates.

Conclusion

Put most simply, increasing interest rates to control inflation makes sense if your starting point is a conventional supply and demand analysis where macroeconomic outcomes can be regulated by demand management. But increasing interest rates to attack inflation makes less sense if your analysis starts by looking at how capital will respond to such an increase, and how that will impact on economic flows in the economy. In this scenario, increasing interest rates is possibly counter-productive (even in its own terms – and not even thinking about the human cost of the “desired” economic slowdown). At best it is a blunt instrument when more direct market interventions (such as price caps or taxes) could better impact on the particularly economic flows driving of inflation.

Or, to put it another way (in light of populist media attacks on Philip Lowe and Michele Bullock), don’t blame the person or personality of the Reserve Bank Governor – blame the economic theory.

[1]              In Shaikh’s analysis, this supply-demand-equilibrium applies as much to Keynesian and neo-Keynesian economics as to neoclassical economics, it is just that the former theories recognise that the equilibrium may, without state stimulus, be below a full employment of resources.