The recent problems in the Middle East have led a number of commentators to speculate that this may lead to higher fuel prices which will undoubtedly lead to higher inflation. Higher inflation will put pressure on the Reserve Bank to raise interest rates with a view to controlling inflation.
Now I know what some of you are thinking… how will raising interest rates help the situation in the Middle East?
Well, the simple answer is that it won’t but – as was pointed out many times when the Ukraine situation led to higher prices – when you only have a hammer then all you can do is hit things and pretend that people with a mortgage are a nail.
Part of the problem with economics is that people don’t understand how it works and the reason for that is: it doesn’t. Or to put it another way, there are many economic theories that are beautiful in their simplicity and they explain quite well the way that things would work in an ideal world that didn’t have other economists or people to stuff up the theory.
Let’s start with the simple idea of supply and demand. In theory, prices move toward a point where demand equals supply. For example, if I’m standing outside a Taylor Swift concert selling autographed photos and I only have ten, I’d be silly to charge $2 for them because I’m pretty sure that I could get more. On the other hand, I’ll have a very long evening if I try to charge $1000 for them. So – according to economic theory – I should be adjusting my price until I find the price at which demand equals supply.
There are only two things wrong here. If I’d started with a price that was too low, then I may have sold them all before they hit the top price I could get for them. On the other hand, if I started at a $1000, I may not care that I’ve only sold one and I’m happy to go home content that I haven’t had to waste a lot of time trying to work out that magical spot where demand meets supply.
Of course, when it comes to Taylor Swift we need to understand that phenomena of inelasticity of demand. Surprising as this may be to all those fans who said that they’d pay anything for a ticket, going to a Taylor Swift concert comes under the heading of discretionary spending which means that you can choose not to go… Yes, this may be a shock to a number of people, but I assure you that even people who aren’t economists will back me on that.
Various other items aren’t discretionary. For example, you can’t say to your landlord that you’re a bit short of money so you’ll only sleep in your home six out of seven nights and you expect your rent to reflect this. You only have a choice of paying your rent in full or moving into your car which is pretty tough choice, particularly for those who don’t own a car. As Joe Hockey famously told us: “Poor people don’t drive!”
So when the RBA puts interest rates up, it’s trying to reduce demand. The only problem is that when the factors pushing interest rates up are items that people don’t have a lot of choice about such as mortgage repayments, petrol, rent, energy and food then the increase in interest rates will drive down discretionary items but overall demand for rest will be relatively unchanged.
Or to put it as simply as I can: putting less petrol in your car won’t change the overall world demand for oil and it won’t drive the price down, so an interest rate hike won’t solve inflation in fuel prices. It may, however, put people out of work in other areas such as hospitality and retail which means that they don’t have to worry about the cost of fuel as they have no job to go to.
If this all sounds a little insensitive it’s because I’m talking about economics and if there’s one thing I’ve learned while reading The Australian Financial Review it’s that there’s only one thing to consider when talking about economics and that’s whether there’s money to be made. It’s one paper that tries to give you good information about what’s actually happening because unlike the rest of the media, people who lose money because they were given incorrect information get far more upset than when politicians tell you that there’ll be no cuts to the ABC, education or health. Of course, you do have to ignore the fact that many of the writers are the sorts of people who’d try to keep their parents out of aged care. Not because of concerns about the welfare of their parents but because they’d have to sell their home and the market should be making a strong recovery next year and their inheritance would be considerably more…
Anyway, the basic problem is that Australia’s inflation problem won’t be solved by the Reserve Bank. In fact, the only thing that we can really do is rely on the federal government to come up with creative solutions to the problems that inflation causes. And, of course, any creative solution will be attacked by the Liberals and the media without coming up with any other solution. It’s only a matter of time before the old “Look at the debt!” resurfaces.
I intend to address the issue of government debt at some future date and to explain how it only matters when they promise to give every zoo in Australia a giant panda, but I’ll save that for another time…
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