70 Years of Inflation in Australia Footnote 1
By Andrew Glassock, Consumer Price Index Section
The September quarter 2018 release of the Australian Consumer Price Index (CPI) marks seventy years of the Australian Bureau of Statistics’ (ABS) CPI series. Publication of the quarterly CPI began in 1960, with the series backdated to September 1948. The purpose of the CPI is to provide a general measure of consumer price inflation in the Australian economy and is the principal measure of inflation used by the Reserve Bank of Australia (RBA) in setting monetary policy.
Australia’s inflation history since the introduction of the CPI can be broken down into four main phases: (i) The initial post-war recovery and the ‘Korean War boom’; (ii) the disinflationary period from 1953 to 1972; (iii) high inflation from 1973 to 1990; and (iv) the period since the introduction of inflation targeting by the RBA. Chief Economist for the ABS, Bruce Hockman explains that in each of these phases a consistent pattern emerges.
“What often happens is that you have some unanticipated change in the global economy, such as an oil price shock, which causes an initial acceleration of inflation or disinflation (a decrease in the inflation rate), often with a lag. The impact of this change is then compounded by conditions in the domestic economy. The inflation rate eventually stabilises once the external shock has subsided, but the effect induced by the initial event persists as domestic policy changes in anticipation of inflation remaining at high or low levels. While there are several fluctuations throughout each period, it is only following another major change in the international economy that the inflation rate is able to transition from a high to low state.”
INFLATION IN AUSTRALIA
CPI movements from the corresponding quarter of the previous year (hereafter referred to as year-ended inflation) are presented in Figure 1. The graph highlights a number of important economic events and policy changes that have impacted the CPI over the past seventy years.
Figure 2 provides a summary of consumer price inflation by decade over the period from 1950 to 2017. This article discusses the key inflationary and disinflationary episodes over the past seventy years.
Post-war Economic Recovery and the ‘Korean War Boom’ (1948 – 1952)
In the early years of the CPI series, expansionary post-war economic activity contributed to high inflation in Australia. The most significant economic event during this period was the ‘Korean War Boom’ which began in late 1950. To some extent, this episode can be thought of as an instance of imported inflation (Stevens, 1992). High world inflation was transmitted to Australia through improvements in the terms of trade Footnote 2 as a result of favourable rural conditions and rising wool prices (Australia’s major export at the time). Export income grew substantially, leading to strong real GDP growth, with domestic demand rising even faster. Each of these factors accelerated the increase in domestic inflation.
Domestic economic policy was also instrumental during the Korean War Boom. The government’s removal of controls over prices, wages, and rationing, as well as post-war immigration and expansionary fiscal and monetary policy, further increased domestic demand. At the same time, the number of industrial disputes rose, which created supply pressures through increased labour costs (Stevens, 1992). While global influences played a major role in rising inflation at the start of the 1950s, domestic demand and supply factors were also important.
In December 1951, consumer price inflation peaked at 23.9 per cent. This remains the highest rate of inflation throughout the seventy years of the Australian CPI series.
Early Disinflationary Period (1953 – 1972)
Although inflation rose sharply during the Korean War Boom, the effects were relatively short-lived as disinflationary pressures quickly set in. Mr Hockman explains how fiscal and monetary policy turned contractionary in order to combat the high inflation:
“The Menzies government implemented two credit squeezes essentially to bring an end to the inflation of the Korean War Boom in the mid-1950s. Constraints were placed on the amount of credit issued by banks, which were operating under a more centralised system at that time.”
Mr Hockman also notes the role of aggregate supply factors as “productive capacity grew sharply”. In what followed, inflation remained relatively low for close to two decades. With the exception of a six month period in 1956, year-ended inflation remained below 5 per cent from 1953 to 1972, reaching an historic low of -1.3 per cent in June 1962.
Stevens (1992) described the mid-1960s as “a golden age for the Australian economy”. International factors were not as significant due to stable international growth and limited volatility in both export and import prices. Contractionary fiscal policy at the start of the 1960s appears to have played a role in constraining demand, while credit controls remained tight. The outcome of these policies was a decade in which inflation and unemployment remained low, while output grew steadily.
Oil Price Shocks and Persistent High Inflation (1973 - 1990)
Although the Australian economy had been showing signs of rising inflation by the end of the 1960s, it was not until the global oil price shock in 1973 that inflation began to increase sharply. The stagflation (high inflation and high unemployment) which resulted from this price shock, and the associated rise in commodity prices, can be thought of similarly to the Korean War Boom in the sense that it was imported inflation, although the impact of commodity prices in the 1970s was more severe than in the 1950s (Stevens, 1992). Large capital inflows during 1971 and 1972, combined with a bolstering of domestic income as Australia’s terms of trade improved, contributed to the rising inflation through escalating growth in the money supply.
Following a brief period of disinflation in the latter half of the 1970s, during which inflation remained above 8 per cent, a second oil price shock in 1978-79 once again caused a rapid acceleration in inflation. The second oil price rise was less severe than the first as the strong growth in export prices was accompanied by similar increases in import prices which mitigated the impact on the terms of trade (Stevens, 1992). The effect of the shock was also short-lived as rising unemployment and a wage freeze in 1982 put downward pressure on inflation.
However, by 1985 inflation began to increase as import prices rose. In response, the nominal exchange rate depreciated. Although traditionally higher import prices had led to disinflation through deterioration in the terms of trade, the recent floating of the Australian dollar allowed the currency to depreciate beyond the level determined by the terms of trade, further pushing up the inflation rate. When global economic activity improved in 1986, rising commodity prices eventually led to an appreciation of Australian dollar and a substantial improvement in the terms of trade (Stevens, 1992). Despite a downturn in late 1987, inflation remained high in the Australian economy until the start of the recession in late 1990.
While international factors played a key role in the high inflation of the 1970s and 1980s, domestic changes magnified the impact of external shocks. In particular, there were important changes in labour market conditions occurring at the start of the 1970s. Although the Australian Conciliation and Arbitration Commission had the ability to ensure wages increased with the CPI, it had limited capacity to prevent wages growth beyond the rate of inflation. Added to this were low rates of unemployment at the end of the 1960s, large increases in public sector wages and court decisions which established gender parity in minimum wages (Stevens, 1992). Each of these factors contributed to the high inflation in the early 1970s by raising the cost of labour.
The introduction of wage indexation (wage increases in line with increases in the CPI) in 1975 coincided with the brief period of disinflation prior to the second oil price shock. However, Mr Hockman suggests that combined with the earlier wage developments, indexation essentially ended up “locking in inflation in the long run”. According to Stevens (1992), the level of real wages initially set for indexation was too high at a time where the wages growth was exceeding productivity gains. This meant that although nominal wages growth fell along with the inflation rate (through the indexation mechanism), the decrease in nominal wages growth was not sufficient to induce firms to hire more workers. Unemployment rose as a result, which in turn caused inflation to eventually rise by contracting output growth. In contrast, real wages were allowed to decrease following the second oil price shock, which reduced the contractionary impact on the labour market and contributed to improved economic activity in the second half of the 1980s.
Recession and Inflation Targeting (1991 – 2018)
The 1991 recession in Australia saw the unemployment rate reach an historic high of 11 per cent and remain at elevated levels for a number of years. This led to a decrease in domestic demand and resulted in year-ended inflation falling to 0.3 per cent in late 1992, its lowest level in thirty years.
Since the 1991 recession, the Australian economy has enjoyed a sustained period of low inflation, with annual movements in the CPI remaining below 5 per cent throughout the majority of the period. This phenomenon is largely explained by the introduction of a 2-3 per cent medium term target of consumer price inflation by the RBA in 1993. In the twenty-five years since inflation targeting was implemented, the annual rate of inflation has averaged 2.5 per cent, compared with an annual average of 8.8 per cent between 1973 and 1993 (Debelle, 2018). At the same time, the annual average real GDP growth rate was higher than over the preceding two decades, with the unemployment rate also lower on average since inflation targeting began. Furthermore, the recent period of low inflation has been characterised by less volatile movements in the inflation rate and other macroeconomic indicators.
While inflation has remained relatively stable over the past twenty-five years, several major economic events caused sharp fluctuations in Australia’s exchange rate and domestic demand, which impacted the rate of inflation. In 1997, the Australian economy briefly experienced deflation as a result of the Asian Financial Crisis (AFC). Exports to East Asia and commodity prices both fell significantly leading to a deterioration in the terms of trade, while import prices also decreased, exacerbating the disinflationary pressure (Debelle, 2018). The deflationary shock caused by the AFC was only temporary, although the headline inflation rate remained low for the following two years.
In the September quarter 2000, the Australian economy recorded its highest rate of inflation since the introduction of the 2-3 per cent inflation target. This inflationary episode was an isolated event due to the introduction of the 10 per cent Goods and Services Tax (GST) on 1 July 2000. This resulted in a temporary impact on the CPI, with inflation quickly returning to normal levels in subsequent quarters.
High commodity prices and growing domestic demand in the latter stages of the Global Resources Boom saw year-ended inflation rise to a peak of 5 per cent in September 2008. However, inflation decreased dramatically following the onset of the Global Financial Crisis (GFC), with quarterly deflation of -0.3 per cent in December 2008. By September 2009, year-ended inflation had reached a low of 1.2 per cent. As the global economy began to recover from the GFC, inflation picked up in 2010 and 2011, with growth of around 3 per cent throughout these years. This was short-lived though as a high Australian dollar, weak wages growth and strong retail competition resulted in persistent low inflation rates around 2 per cent for the majority of the period from 2014 to 2018.
Looking at Australia’s CPI over the past 70 years shows how Australia has experienced long periods of high inflation, disinflation, and more recently, low and stable inflation. The CPI reflects the impact on the Australian economy of global influences, such as oil price shocks, as well as domestic effects, such as policies that impact the labour market and wages growth.
The CPI continues to be the pre-eminent measure of inflation in Australia and remains an important macro-economic indicator. The CPI is used to inform policies by government and the RBA, such as monetary policy, and the decision making by Australian businesses and the community in general.
Stevens, G. (1992) ‘Inflation and Disinflation in Australia: 1950-91’, Reserve Bank of Australia Conference paper.
Debelle, G. (2018) ‘Twenty-five Years of Inflation Targeting in Australia’, Speech at Reserve Bank of Australia Conference.
The paper ‘Inflation and Disinflation in Australia: 1950-91’ by Glenn Stevens of the RBA, provides an interesting description of Australia's history of inflation prior to 1991. This article summarises parts of the Stevens (1992) paper and a recent interview with the Chief Economist for the ABS, Bruce Hockman.
The terms of trade is a measure of the relative prices for exports and imports.