The two inflations

On 3 May 2022, the Reserve Bank of Australia raised the cash rate for the first time since November 2010. The rate had been 0.10 per cent — a record low set during the COVID pandemic to support the economy.

By November 2023, the RBA had raised the cash rate thirteen times, taking it to 4.35 per cent. That is the fastest tightening cycle in Australian history. Variable mortgage rates surged 69 per cent from May 2022. On a A$500,000 loan, monthly repayments increased by approximately A$1,210 by April 2024 compared to April 2022.

The RBA’s cash rate pass-through data tells the full story: the 425 basis point increase in the cash rate translated to approximately 320 basis points in increased mortgage payments for outstanding borrowers. The shortfall reflects the fact that a significant proportion of borrowers had locked in pandemic-era fixed rates. When those fixed rates expired — mostly during 2023 — those borrowers moved from approximately 2 to 2.5 per cent onto approximately 6.5 per cent. For them, the effective rate increase happened all at once, on a single day.

The argument that the 2022–23 Australian inflation was predominantly supply-side is not a fringe position. It is well-documented in the RBA’s own publications and in the academic literature.

The Australia Institute and the Centre for Future Work conducted research finding that the inflation that led to the Reserve Bank raising interest rates was caused overwhelmingly by companies abusing market power to raise prices. This is the corporate margin expansion argument: during a period of supply disruption and generalised price uncertainty, companies with market power raised prices by more than their cost increases warranted.

The ACCC’s supermarkets inquiry confirmed a version of this finding: grocery prices rose 24 per cent over five years; EBIT margins expanded; the regulator found that at least some of the grocery price increases resulted in additional profits. ACCC legal action against Coles and Woolworths for misleading discount pricing covered exactly the period of the inflation peak.

The Ukraine war explanation is straightforward: Russia’s invasion in February 2022 caused immediate global spikes in energy and food prices. Australia imports refined fuel and many food inputs. The global energy price spike fed directly into Australian petrol prices, transport costs, and through them into the cost of almost everything. The RBA raising the cash rate did not produce more Ukrainian wheat or more Russian gas.

The supply-side critique of the rate rises does not argue the RBA should have done nothing. There was a genuine demand element to Australian inflation. Australia’s rapid reopening from COVID restrictions in late 2021 produced a significant surge in consumer spending into a supply-constrained environment. This demand element was addressable by rate rises.

The RBA’s position — articulated by Governor Philip Lowe throughout 2022 and 2023 — was that even supply-side inflation can become entrenched if inflation expectations become unanchored. Workers who believe prices will keep rising ask for higher wages. Companies that believe wages will keep rising raise prices. The rate rises were partly intended to demonstrate the RBA’s commitment to its target, not just to directly reduce demand.

These arguments have merit. The critique is not that the RBA was wrong to act, but that it used the only tool available to it — interest rates — as the sole instrument of stabilisation, while fiscal policy remained largely passive. The 2023 Independent RBA Review acknowledged the importance of fiscal-monetary coordination. It noted the limitations of monetary policy working alone.

When a central bank raises rates to address predominantly supply-side inflation, the mechanism does not work as textbook economics implies. The Australia Institute described it precisely: rate rises were not so much dampening demand from growing incomes as keeping households’ heads below water.

Real wages fell approximately 5 per cent from 2021 by the RBA’s own measurement. Household disposable income fell 6.1 per cent in the year to September 2023 — the largest decline of any OECD country. Economist Chris Richardson said the impact on living standards was far greater than anywhere else and larger than anything recorded since 1959.

The Australia Institute calculated that for a typical couple with a A$660,000 mortgage, the combination of falling real wages and rising interest rates reduced their after-tax, after-mortgage income by 26 per cent in real terms over twelve months. That is not fighting inflation from a position of strength. That is a policy that took households which were already struggling under supply-shock price rises and made their financial position dramatically worse.

The supply-shock did not require borrowers to bear the entire burden of stabilisation. Fiscal tools were available. Windfall taxes on companies expanding their margins during the inflation period would have both raised revenue and dampened the corporate margin expansion that contributed to price rises. Price transparency and consumer protection measures could have moderated the supermarket margin expansion. The government chose not to deploy these tools. Articles 3 and 6 of this series examine why.