Talking inflation with Melbourne economist Vinod Mishra

By Indira Laisram
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Vinod Mishra

The Reserve Bank of Australia (RBA) on June 7 increased the cash rate target by 50 basis points to 85 basis points, the second time in five weeks. It also increased the interest rate on Exchange Settlement balances by 50 basis points to 75 basis points. “Inflation in Australia has increased significantly. While inflation is lower than in most other advanced economies, it is higher than earlier expected,” said Philip Lowe, Governor, Monetary Policy Decision.

Against this backdrop of gloomy economic news, The Indian Sun speaks with Vinod Mishra, Deputy Head of Economics in Monash Business School, Monash University, Melbourne, to get an insight into what the figures foretell. Associate Professor Mishra is an Applied Economist focusing on conducting empirical research on different aspects of the Indian, Chinese and Australian economies. He has published more than 60 research papers in leading international journals in economics, finance, and related areas. Apart from teaching and research, he also comments on current economic issues, volunteers for his local council’s interfaith network, and is an active member of the Indian community in Melbourne. In conversation with Vinod Mishra.

What’s the root cause for inflation in Australia? Quantitative easing or war?

Inflation can rarely be attributed to a single cause. The current rise in inflation is because of several factors, such as pent-up demand due to the last two years of Covid lockdowns, near-zero interest rates for a while, money pumped by the government through Covid support payments (such as job keeper and tax relief), supply-chain issues in the global economy and, of course, the geopolitical tensions including the Ukraine crisis. All these factors are contributing to inflation.

What does a deeper dive into the latest inflation figures tell you? Is it scary?

I am optimistic that this rise in inflation will not last long. The pent-up demand, supply-chain constraints and the Ukraine crisis are all such factors that cannot go on for a long time. As soon as these factors start to resolve, I expect inflation to start going down. We also need to be mindful that the RBA is officially committed to keeping the inflation under a targeted band of 2-3%. Right now, the inflation is above the RBA’s targeted band; however, if it stays that way, RBA is bound to intervene to bring the inflation back to the targeted range.

There is a slight probability, albeit small, that the optimistic scenario may not materialise, and we end up with a price-wage spiral leading to a ‘70s style inflation cycle. Price-wage spiral refers to a situation where workers expect prices to rise in the future and hence negotiate higher wages, which contributes to further price rises, creating a spiral of ever-increasing prices in the economy.

What tools do policymakers have to deal with inflation in the worst-case scenario?

One essential tool policymakers have available to deal with inflation is the interest rate or money supply. Both money supply and interest rates are two sides of a coin. If the interest rates rise, people are reluctant to borrow to buy things and unwilling to take money out of banks (depositors)—which reduces the amount of money circulating in the economy and slows down business activity, thereby cooling off the overheated economy. However, policymakers need to be cautious in using this instrument as excessive rate rises may cause a recession, i.e. dampen the business activity too much.

Other tools to deal with inflation are direct price and wage controls. Government can fix the prices and wages in specific sectors of the economy to break the price-wage spiral. However, past evidence suggests that such measures are not very effective in controlling inflation and end up distorting the market. For example, a government-imposed rent control intended to help renters with the cost of living ends up disincentivising the landlords from maintaining the rental properties and discourages them from putting new properties for rent, thereby reducing the quality and quantity of properties available for rent.

Government can also cut its spending and raise taxes to reduce the inflationary pressure on the prices. However, such measures as usually politically very unpopular.

Any tips for families on how to manage their budgets under such inflationary conditions?

I can think of a few things that we can all do to fight inflation. For high-value items (house, car), it is better to buy rather than rent or lease. Rents go up with inflation, whereas mortgages and auto loans can be fixed at a specific interest rate—thereby taking the unpredictability out of these expenses.

For small items (clothes, furniture, appliances), I think it is better to focus on buying long-lasting and durable things (rather than fast-moving use and throw items). Adopt the habit of repairing rather than replacing.

Moreover, households must have a budget and strictly stick to it as much as possible. Have some money set aside as an emergency fund to deal with unexpected shocks.

These are the tips we would typically have heard from our parents or grandparents; however, we have to be mindful that they lived through the high inflationary era of the 1970s.

Do you believe housing in Australia is in a bubble? Will rising interest rates ease the property market?

In the last ten years, I have repeatedly heard that the Australian housing market is in a bubble and that a market correction is imminent. However, it hasn’t happened so far, which makes me think that the housing market in Australia is probably not as speculative as we would like to think.

I believe that the rising interest rates will ease the property market—some early signs of that happening are already visible in the property market. However, I do not think that there will be as many successive interest rate rises as some people are predicting, and consequently, the drop in house prices will also be not as significant as some are expecting. I think RBA will be mindful of over-targeting inflation, as that can lead to recession.

Housing affordability is a brewing crisis in Australia. In your opinion, how do you think the new government will tackle this crisis?

Housing affordability is a big issue, and I think addressing this would be a significant challenge for the new government.

I find it hard to speculate how the new government plans to tackle housing affordability. Some measures that government can take would be to invest more in public housing, change the regulatory framework to let people buy a house by paying lower deposits or government underwriting / providing guarantee for some part of the home loans, changing the tax framework around housing (for instance, lowering stamp duty for first home buyers etc.).

Some long-term measures that government can consider would be to relook at the negative gearing, addressing the supply bottleneck in the housing construction market. However, these measures are usually very politically controversial, and the government may be reluctant to touch upon them.

If median prices in Sydney and Melbourne remain around 1 million, how will new home buyers and immigrants be able to afford housing in Australia? Are such high prices sustainable?

The unprecedented growth in the house prices is a real worry, especially as you rightly pointed out, for the housing affordability for the first home buyers and newly arrived immigrants. The genuine concern is that the growth in housing prices in the last few years has been higher than the growth in wages or increase in savings, which indicates that no matter how much you save, you will never be able to keep up with house prices to pay a deposit and get a mortgage.

I do not think such an out-of-control price rise is sustainable. My prediction is that the growth rate will slow down over the next few years; however, I do not think something dramatic or sudden will happen.

Demographics are not on our side. We have an ageing population, and Australia is an expensive place to move to for migrants. High property prices will discourage new migrants to move here eventually, and we run the risk of becoming like Japan. Your thoughts.

An aging population and rising dependency ratio is a problem for the developed world, including Australia. We do run the risk of becoming like Japan in the long run. Government policies like incentives for increasing women’s labour force participation, subsidising and increasing access to childcare and a more relaxed immigration policy can help mitigate this problem.

Quantitative tightening in the US has seen the stock market dip like we have never seen since the 1920s. We have seen major corrections in the crypto markets. Housing data from the US is not very encouraging. We have over 0.17 defaults in mortgage repayments already. That’s almost at par with the crisis in 2008. Where do you think all this is heading for the American economy?

It seems that the US is heading for a recession. Although most predictions are that it will be a mild recession compared to the 2008 crisis. Nevertheless, a recession in the US will invariably impact most countries in the world and will have the most significant impact on the most vulnerable sections of the economy. Things like rising fuel and food prices, coupled with high unemployment rates, will substantially affect the poorest sections of society.

What kind of impacts will Australia have once America goes into a recession?

The US is Australia’s third-largest trading partner and accounts for around 8-10% of total two-way trade for Australia. A recession in the US means a drop in the demand for Australian goods and services in the US and, consequently drop in trade. We can also expect a decline in US investment coming to Australia. While these things will undoubtedly create pain points in specific sectors of the Australian economy, I believe the overall economic performance will be primarily driven by the performance of the domestic economy and the size of its trade with Asia.

Tell us about the macro conditions in India. Where is India headed economically in the immediate future?

If we go by International Monetary Fund (IMF) predictions, India will be the fastest-growing economy in 2022. The IMF also adds that India is likely to be a $5 trillion fifth-largest economy by 2027. So, it seems to me that the next few years will be a feel-good story for the Indian economy. Of course, this assumes that something unprecedented like another pandemic or war will not occur.

A few structural changes that are likely to drive the growth of the Indian economy in the next few years are strong digitalisation drive by the government (things like Aadhar, UPI payments etc.), investments in infrastructure and renewable energy, development of the large single national market and a significant dominance in the global IT space and movement of manufacturing and supply chains away from China.

India has a foreign reserve of around $600 billion. With rising American dollar and QE, does India run the risk of losing most of its foreign reserves? In other words, Is India looking comfortable with its reserves now?

I do not believe India will run out of foreign reserves anytime soon. The reserves do fluctuate in the short run due to exchange rate fluctuations; however, as mentioned above, the fundamentals of the Indian economy are strong; hence I won’t worry about the foreign reserves.


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