18: Your Monthly Budget. Will inflation make it explode?

Your Monthly Budget. Is inflation about to make it explode?

Cherelle Murphy - E.Y. Chief Economist Oceania

Announcer: Welcome to Burgernomics, demystifying economics with Ross MacDowell.

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Ross MacDowell: Hi, I'm Ross MacDowell. Welcome to Burgernomics, the podcast that demystifies economics, applying it to your life. Today's topic is, Your Monthly Budget. Is inflation about to make it explode? Every economist's nightmare is the 1930s black and white photo of a German woman stuffing her stove with banknotes to boil her kettle, because inflation had made those banknotes almost worthless. Just imagine that for a second.

It's like you're starting your own barbecue with $20 notes, because you can't afford the inflated price of firewood. Australia has never experienced inflation at that level, but we have experienced 23.9% inflation in 1951 during the Korean War, 17.7% inflation during the 1975 OPEC oil embargoes. Now, after decades of almost no inflation, it's back. Lots of Australians are wondering how inflation will affect them.

I personally have lived through inflation, which caused the interest rate on my very first home to rise from 9.1% in 1980 to 17% 10 years later. An 8% mortgage increase was a terrifying experience. Today's podcast, discussing inflation, is one that I've been waiting to have for a long time, so it's going to be fascinating for me. To demystify inflation for us today is Cherelle Murphy, Chief Economist for EY, one of the big four advisory firms operating in Australia.

Prior to EY, Cherelle was chief economist for Austrade helping guide Australian government policy and trade, foreign investment, and tourism. Cherelle spent 15 years at the ANZ Bank after starting her career as an economic research analyst at the Reserve Bank. She's also worked as a journalist for the Australian Financial Review. Cherelle, an especially big welcome from the Burgernomics podcast to you being our first female guest economist.

Cherelle Murphy: [chuckles] Thank you very much. It's an absolute pleasure to be here. I hope that you can have many more female economists on in future.

Ross: I'd like to do that. Now, Cherelle, why for literally decades are economists so frightened by inflation?

Cherelle: Well, we're starting to see it pick up, as you said in your introduction. That, of course, makes us all a bit nervous, particularly economists of my generation, because we've barely had to deal with inflation as a problem. We've been much more focused on other economic issues and particularly employment, so this is new territory for us. We are seeing it not only pick up in Australia but also around the world.

As I'm sure your listeners would know in the US and UK, they're seeing multi-decade highs in the rate of inflation. It is worrying, of course, because what it does is essentially eat away at our purchasing power, and that is not desirable for anyone.

Ross: Just tell me what is inflation?

Cherelle: Inflation is essentially the movement in consumer prices. We measure it using the consumer price index, which is an index. It doesn't actually tell you anything about any one particular price. It's just an index. It revolves around 100. What that does is it measures the quarterly changes in the price of a fixed basket of goods and services. That basket of goods and services is supposed to really represent the average expenditure by a household in Australia.

Ross: Does it? That would be my question.

Cherelle: Look, it's as good an effort as we can make. It's basically split into 11 groups, or the items, which the ABS. When they're calculating this index, they group all the goods and services that we purchase as households into 11 groups. Those are split further into 87 categories, but there's actually thousands of items in there, so it's quite an extensive basket, so to speak. It's not perfect. Some people would perceive it not to reflect their prices because it doesn't include house prices.

The reason it doesn't do that is because it's essentially measuring business-to-consumer purchases and government-to-consumer, so it doesn't include consumer-to-consumer if you like. The cost of an existing house is not included. It does include the price of building a new house though, and rents and utilities and that sort of thing. If you like, I could give you a bit of an idea of the different weights in that basket if that would be helpful.

Ross: Sure, yes.

Cherelle: Housing is 23% of the basket. Food and non-alcoholic beverages is the next biggest category at 16%. Recreation and culture is 13%, transport, 11%. Furniture and household equipment and services, that's 9%. Interestingly, childcare is in there because household services are in there. Cost of our cleaners, et cetera, would be in there. Then we have alcohol and tobacco, which is 8% of the basket. Health is 6%. Isn't that concerning, that we spend more on alcohol and tobacco than we do on health?

Insurance and financial services, 6%, education, 4%, clothing and footwear, 3%, and finally communications at-- That gives you a rough idea of how we spend. The spending categories and the weights are calculated by the ABS reflecting their household expenditure survey. They're quite technical in how they actually come up with those weights.

Ross: Currently, what's inflation running at?

Cherelle: In the December quarter of 2021, which was our last CPI number, the quarterly increase in prices was 1.3%. Over the 12 months to the December quarter, the CPI rose by 3.5%. Unsurprisingly, the strongest categories in that quarter were for new dwelling purchases by owner-occupiers. As we know, the purchasing of purchase of new home or building of new homes and automotive fuel, which went up by 6.6%.

Ross: If we are basing our feelings about inflation and our purchasing power on this index, if I look at, for example, you brought up fuel. If I look at petrol, in the last 12 months, petrol's risen from a $1.39 a liter to a high of $2.5. That's 47%. If a person is filling up their 60-liter fuel tank once per week, then that's costing them an extra $2,060 a year. Maybe they also have the odd steak at home. That's gone up 20% in the last year.

If they've done a renovation, that's gone up 20% too. It would appear that a lot of costs have gone up so quickly that that's not really being reflected well in an index that's saying 3% to 4%.

Cherelle: You're right in the sense that there are definite categories of spending that have gone up very, very quickly. As someone who is renovating a house right now, I can attest to that 20% rise in home building costs. All my builders will tell me that the cost of finding timber or just finding timber, full stop, is very difficult. Therefore, of course, it becomes more costly. They quickly pass that price rise on to me, so I understand.

At the same time, you're also forgetting the fact that some prices have actually gone down. We would have seen, for example, some household equipment prices go down. If we think about, obviously, IT equipment, solar panels, that sort of thing, there are actually things, believe it or not, that move the other way. We don't tend to think of those though so much, because we don't tend to buy them very often. They tend to be the less frequent purchases. We get less excited by the price of those things changing.

If we're paying our childcare bill, for example, every week, and that was going down every week, we'd probably get pretty excited by that. Of course, it's not, it's going the other way. Whereas the TV that you buy once, maybe every 3, 4, 5 years, that price is probably coming down, or you're getting a better quality TV for the same money. That has to be counted as well because we're talking like for like here. If you're getting better quality, then you're technically buying a better product, and it would cost more normally. Of course, if it's coming down in price, then you're getting a double bonus there.

Ross: You think, psychologically, people that are only looking at what's going up, what they see on a regular basis, regular purchases, grocery, petrol, alcohol, those sort of issues rather than bigger ticket items that they're not purchasing as frequently?

Cherelle: That's often the case. That's why psychologically it doesn't feel representative I think of what we're forking out every week. The other big one of course is house prices. The cost of buying an existing home feels astronomically expensive for most of us and that isn't reflected in the CPI. I think that's something else that means that people don't perceive the CPI to be very accurate as to what they're spending.

Ross: Would you put it into the CPI?

Cherelle: No, I wouldn't, because it's not I guess a reflection of what we're trying to capture in the CPI. It's also not in line with international standards so we'd get ourselves into all sorts of complicated trouble there, honest, from the statisticians. We wouldn't want that, but the other thing is it is an asset price. It is an appreciating asset. It belongs in a different category if you like.

That's not to say we shouldn't of course put that into the mix when we're thinking about policy and we're thinking about how to deal with some of the problems that we're facing. It's clearly very important to include it there, but in terms of actually putting into the CPI, it's not really particularly.

Ross: In dealing with inflation if I'm a household, I've got four options in trying to cope with increased prices. I can change my purchasing habits so that I can afford the same basket of goods, but I'm not getting as many goods in my basket if you like. It's the first thing I could do. I could dip into my savings and continue to buy exactly what I've been buying before and finance it through my bank account.

I could wait every 12 months and see if the government's going to be kind to me and give me some money from their budget which is what they've just done in terms of handouts. The last thing I could do is I could ask my employer for a wage increase to compensate me for the increase in CPI. There's this economic term called the wage-price spiral which is all to do with inflation. Could you just talk a little bit about the wage-price spiral?

Cherelle: It can go up or down as spirals can do. Let's say we see as we are at the moment the prices of the goods and services that we purchase regularly going up and petrol is an obvious example here, and we're feeling the pinch. We have some bargaining power with our employer, then we can ask the employer to compensate us for that extra expenditure that we have to make to essentially remain the same.

In other words, we're not getting more for our money. It's just costing us more. The employer, depending of course on who he or she might be able to replace us with, may say yes or no. If they say yes, then you do tend to get an increase in wages. Then when you put wages up, of course, that makes expenses more problematic for the employer in the sense that their costs go up.

They start putting the prices up and then you get into the spiral as you can see, you see that the prices of perhaps goods that they're producing need to go up. The consumer, also the worker, needs more money to pay for those and you're back into the same cycle again. That's it in a nutshell and it also can work the other way in the sense of when things are weak, but we tend to see it more on the upside.

Ross: Okay. You've got increase in wages that the employer who's producing a good or a service has to pass that on. That creates inflation. We're giving the worker more money so he can go out and buy more things and it can keep on going, can't it?

Cherelle: It can. That's right. In the past, we have definitely seen examples of that. I think what's happened recently though is that for whatever reason, that wage link hasn't been as strong. In other words, when we're seeing activity in the economy pick up, the wages don't necessarily go with it. There's a number of reasons for that. There's structural reasons, there's globalization reasons.

When you think about the labor market these days, we as workers are competing with those offshore more than we used to. Even economists like myself can quite easily be hired in a different country on a lower wage if the employers doesn't see much difference in the ultimate benefit that they're getting. We are competing with those who are willing to work for less than us.

The structural changes may be around the makeup of the labor force, the unionization of the labor force, enterprise agreements. One factor which has been particularly important of late has been state governments who have been putting wage caps on their employees.

Now, state governments employ a lot of Australian employees. In fact, I think around a third and that therefore when they've got 1.5%, 2% wage caps has a big influence on the Australian labor market as a whole.

Ross: Okay. At the moment, we're pretty close to what I would call economic nirvana. We've got inflation running 3%, 4%, 5%. I don't think statistics can ever be exact. We've got some wage growth. We've got full employment. What's created inflation this time around and whose responsibility is it to fix inflation?

Cherelle: We have inflation this time around for a number of reasons. As always these things don't tend to be driven by just one factor. At the moment we've got a number of things going on. We've got the oil prices, global oil prices obviously have risen. They've also fallen and risen and they've been quite volatile, but they've certainly on an upward trend as we know in recent months.

We've got the stimulus that's in both the domestic economy so in the Australian economy as well as international economies because of COVID. The recovery and I guess the emergency supports that had been put in place by our government and governments around the world has created a lot more money in the economy. That money, of course, has generated activity and the activity has generated demand for labor.

There is some increase in wages coming through with that and there's also some price increases coming through with that. At the same time, of course, we've had this terrible situation in Ukraine which has blocked the supply of a number of important commodities that we and most of the rest of the world rely on. Whether or not we buy them from Russia and Ukraine or from other countries, but it certainly tightened the supply of wheat and oil and gas in particular. Because there's less supply, we are seeing, of course, people bid up the price for that and that's caused as we know the petrol price situation to get worse as well as pushing up food prices.

Then as if that's not enough, we've also had of course the recent floods in Queensland and New South Wales which have destroyed many crops. That too is putting upward pressure on prices of some foods, because of course again, it tightens the supply, and when you tighten the supply, people have to pay more if they would like it and that's quite inflation.

All these things have come together in quite a short space of time and quite concentrated. That's why we're seeing inflation suddenly back in the headlines.

Ross: How transitory do you think all these factors are? Are they here just for a short time or are we looking at inflationary pressures, because of the wage-price spiral that you talked about before where all of a sudden to compensate for these quite immediate price increases we're having to compensate wage earners, and then it kicks off the spiral or do you think this is something that is short-lived?

Cherelle: I think the answer is somewhere in between, and I don't mean to be a fence-sitter here. I think some of the factors will be short-lived. If we think about, for example, the global supply blockages I guess that we've had in the last two years caused largely by COVID, and the fact that people were demanding a lot of good services. We had this surge in demand for goods. That should settle down. Two reasons would be because people are more adjusting back to the normal balance of goods versus services. The extreme demand for goods should settle down a bit.

At the same time, you've got those that can supply shipping services. For example, actually putting more capacity into the market, more containers are being built, more shipping lines, more operations. Of course, as COVID comes out of the equation and people can operate commerce a bit more normally, then that doesn't create problems. The price increases that we've been getting because of that reason should dissipate. There's no reason to expect that they wouldn't.

The global oil price has been going up very sharply and to continue to produce inflation would have to continue to be going up. I'm certainly not calling the top of the oil price spike, but we wouldn't expect it to continue to increase at the rate that it has been. If oil prices remained high but didn't actually grow anymore, then that would I guess cease to become a reason why inflation continues to move up. There are other factors though that make me think some of these price rises will certainly continue, and as you say this wage-price spiral idea is probably at the core of that.

We would expect to see some push up in wages whether or not it is substantial is a very difficult question to answer, but for the reasons I was explaining before that wages just don't rise as quickly as they used to in the past makes us think yes, we'll see some increase in wages, but it's not going to be ridiculous and it's probably not going to get away from us. You can see that there are some factors that would keep inflation moving along and continuing to just potter along at a rate that we haven't been used to so a bit higher, but there's some factors that definitely should fall out of the equation and may even have a temporary deflationary impact on prices too.

We haven't mentioned so far also the government's budget measures including the temporary reduction in the fuel excise. Now, that is something that is going to have a very short-term decrease on prices potentially. I'll come back to that in a minute, but then when the fuel excise goes back to normal then it actually causes prices to jump again. The same thing happened when the government put in place free childcare during COVID. We had a very quick downward movement in prices, because the cost of childcare, well, essentially became free, and then equally it went back up again. Some of these forces are very deliberately temporary and put in place by government.

Ross: Well, it's costing me an extra $2,060 per year, because of the price of fuel to fill my 60-liter tank. The government's contributing $686 toward reducing that so it's still leaving $1,300 there. Let's get to the bad guys. The bad guys are the people that are going to try and reduce inflation when it happens and the Reserve Bank and the government monetary policy and fiscal policy. Please explain how the Reserve Bank will try and keep a lid on inflation because what is the Reserve Bank's mandate? Everybody wants to have a different view of it whether it be keeping full employment or keeping interest within a certain range, but they're signaling that they're going to increase interest rates. They're doing that because they want to keep inflation down so tell us a bit about the mechanisms that they can use to do that.

Cherelle: First of all, I have to disagree with you the Reserve Bank are the bad guys. What they're actually trying to do is to maintain a strong financial system, keep the currency stable, keep full employment. It's just that sometimes the only way that they can do that is to increase interest rates.

Ross: I probably didn't mean that they're bad guys from my point of view, but certainly, the government like to call them bad guys depending upon where you are in the election cycle, and householders would probably call them the bad guys when they start to increase cash rates, but all of [inaudible 00:24:13]

Cherelle: It feels like they're the bad guys, that's very true. That's very true. You're right that the Reserve Bank will use money to try and fix inflation. By law, the Reserve Bank as I said is actually required to keep the currency as stable as possible, to keep full employment as much as possible, and to promote the economic prosperity and welfare of the Australian people. It does that by meeting medium-term inflation target which at the moment is 2% to 3% and always has been since it's been in place. I don't see that changing. It also, of course, in the background is working to maintain the strength of the financial system and the efficient payments system too which are really important parts of its task.

In practice, it does that by changing the cash rate which is I guess the benchmark interest rate in the market. It's the rate at which all other market interest rates move off whether they be bank to bank, bank to consumer, short-term mortgage rates, credit card rates, they all are essentially anchored off this cash rate. It's not a perfect relationship, and you'll remember through the global financial crisis when we saw the banking sector increase interest rates when the Reserve Bank wasn't. It's certainly not a one-for-one, but essentially, that is the benchmark and it's a very powerful influence on financial markets.

Of course, when they see prices rising, their one policy tool is to increase the cash rate and slow down demand in the economy by taking a little bit of money out of our pockets as we repair our mortgages, a little bit more money than we had taken out last month anyway. In doing so, it's taking some of the what they'd see froth out of the economy and starting to cool the economy which should also--

Ross: Okay. They're also the entity that participated in quantitative easing which was injecting $3.8 billion of new, fresh money into the Australian economy every week. That was because the cash rate wasn't really working, it was the lowest it had ever been. Came down to zero which is basically technically where it is at the moment. They did again what certainly through my generation was the great fearful thing that any central bank would do was print money. That's going back to the black and white photo of the lady stuffing a stove full of banknotes and boiling the kettle, using the flames from the notes rather than from the wood she couldn't afford.

In 2008 when we had the great recession, they reduce the cash rates down to nothing. In many countries, they had negative cash rates so you would be paying a bank to hold your money in their accounts to capitally protect it. They printed money and now they've said they're going to stop to do that, we're ceasing quantitative easing, and we're going to slowly increase rates so that's throwing water on what they regard as an economy that may be overheating. That's their viewpoint and they're an independent organization.

Cherelle: Indeed yes.

Ross: Then we've got the government through fiscal policy which is a fantastic Latin term for just spending money or not spending money.

Cherelle: Or not, yes.

Ross: They've decided to spend $80 billion of money that they don't have out of this last budget, and that would increase economic activity, wouldn't it?

Cherelle: Yes, but the deficit is $78 billion or projected to be $78 billion next financial year. Of course, we never really know until we get there, but last year, it was-- I should say the current financial year it's 79.8 billion which means that the deficit is actually smaller next year than this year which means that relative to the last budget update it's actually very, very mildly tighter policy. Yes, we have a government that's got an expansionary fiscal policy in the sense that there's a deficit and they're basically putting more into the economy than they're taking out as a sector. The government's putting more cash into the economy than it's subtracting through taxes and the other ways that it does.

Of course, part of the reason for that is because of COVID, and we are in particularly unusual circumstances, and the size of the deficit is particularly large because of that. What really matters is what they do with that from here, and the fact that they have projected to get back to a small deficit faster is actually news reflecting the fact that the economy is picking up, and they feel like they can do a bit less.

Could that deficit have been much smaller than 78 billion? Absolutely. Could it be less deflationary on the economy? Yes, but I'd say that they're heading in the general correct direction. I would like to have seen them actually not spend any of the- what we've been calling the windfall gains from a stronger economy that made that deficit smaller. That $78 billion deficit could have been something closer to 60 had they not done that, but generally, they're heading in the right direction.

Ross: The Burgernomics podcast's previous guest who is Associate Professor Steven Hamilton of the George Washington University, we were talking about the sanctions against Russia. He believes the Australian Treasury Department's forecast of inflation peaking at 4.25%. Then in three years decreasing. In other words, he's saying that the Treasury Department is forecasting deflation in three years. He believes that this is illogical, because we've got so much money in household savings. We've got people that haven't been able to spend money because they've been lockdown due to COVID. There's government budget handouts in this current budget, and we've got increasing wages. He only sees inflation going up and up and up.

We see the Reserve Bank probably agreeing with him going, we need to throw some cold water on this yet we see a government going, we're going to hand out some money. There's a conflict here, isn't there? It is the government trying to make voters happy with handouts. Then the RBA is then trying to take them away with higher interest rates so potentially higher interest rates.

Cherelle: Yes, certainly on the surface, it looks like that, doesn't it? As I said before, the government could have spent less in this budget. It's not particularly welcome from the Reserve Bank at the moment for some households to be getting a $250 cost of living payment, and other households when they finish the tax return this year getting another $250 when they submit their tax return. To the extent that we're adding 1.5 billion into the economy from those social security hold or should say pension holders, $250 payments. For the low and middle-income tax recipients another 4.1 billion. Essentially, that's money in the economy, $5.6 billion that the RBA would rather not there at the moment, because they are on the cusp of raising interest rates.

It's important though to also ask a question, is it a big enough sum of money to actually realistically cause the Reserve Bank to be acting differently from what it would've been before? What I'm trying to say here is that the reason the RBA is lifting rates is we're already baked in the cake. This doesn't help. No, and I don't think the RBA had they had control of fiscal policy as well would've done the same. That sum of money is the equivalent to roundabout six weeks' worth of spending on cafes, restaurants, and takeaway food in the Australian economy. It's not huge. It's not a massive part of consumption. It's not a massive part of household income.

I don't realistically think it's going to completely change the way that the Reserve Bank goes about lifting rates. The RBA are going to be lifting rates anyway. They're normalizing the interest rates. They are lifting it from what is an exceptionally low level as you say, practically zero to something that's more sustainable and more appropriate for the economy in this stage of the economic cycle. This fiscal impact, as I say, not great, but not a game-changer.

Ross: Okay. Just before we get onto my favorite topic, we're currently at 4% unemployment. They're saying that it's going to go down to 3.8% unemployment. We are at full employment. That's the definition of full employment is 4%.

Cherelle: Roughly, yes. It changes, but roughly, yes.

Ross: Okay. I am sure that there are so many of our listeners that are scratching their head now going, "Hang on, why can't full employment be 0%? Why is full employment roughly 4%? What's the 4%?"

Cherelle: Well, it's quite a simple answer here. It's essentially people who are moving between jobs. It's called frictional unemployment. At any one time in the economy, as you can imagine, you have people moving in and out of the labor force. In fact, I'm only three weeks into my new role. There was a period of a week there where I decided to take off a holiday, so to speak. I left my old job and I didn't start the new one until a week later. For that week, I was unemployed, I was frictionally unemployed. That's just normal behavior throughout the economy. It happens all the time. It's something that we've been observing for a while. It's quite a straightforward answer, that one.

Ross: What you are saying is that of those people that qualify to be employed, 4% of them at any one time are in between jobs?

Cherelle: Just moving around. Yes. That's right. Frictional unemployment. Of course, as you said before, statistics are not that perfect, that we can say that that's the exact number, but that is roughly what we're measuring.

Ross: Okay. Now the US, they're going through inflation. A little bit more pointed than our inflation is, but not much, just a bit more. To quell their inflation, it would seem that everyone in the US is predicting 10 interest rate rises each of a quarter of 1% all within 12 months. They're saying the cash rate in the US is going to go up 2.5%. In Australian terms, if I was the average mortgage holder of a home, which is about $600,000 at the moment. That's an extra $15,000 per annum, after-tax that I would not have to spend on other things. That's pretty dramatic amount of money, but that's the US experience at the moment.

Now, without getting into this great technical discussion about bond yields. Bond yields are predictors of what's going to happen in the future. I like to think of them as funnels. You get all this information, all this disparate economic information, financial information, investment information, global trading information. Considering that the bond markets dwarf the size of all the equity markets around the world, all this information is put into this big funnel and it pops out these things called bond deals. Let's not worry too much about how some things are calculated.

The Australian government three-year bond yield, which is basically a prediction about where the bond traders think interest rates are going to be in three years. That bond yield has gone up 2.4% in the last nine months. The bond traders are predicting it's going to go to 3%. If that was to flow through to the cash rate of which it would, if it's correct and bond traders traditionally are pretty correct, and then that cash rate flows through to mortgage rates of which they invariably do.

That means that in three years' time, Australian mortgage holder of $600,000, he's going to have to find $18,000 extra per year after tax, just to fund the same house he's living in. That's an astronomical amount of money. Then if I read today's financial review, there are 36 bank economists who on average, believe that by December 2024, the cash rate will be slightly less than that, 2.28%, that's $13,680 per year more or $263 per week more for the average mortgage holder to find. If we look somewhere in between $13,618 a year, that's one mighty big wage increase. Everyone's going to be screaming out for just to maintain their own standard of living that they're currently enjoying.

Otherwise, that's a lot of goods and services that are not going to be bought and not be produced. You'd have to say that the country would go into a recession and possibly a housing crash.

Cherelle: Well, there's a couple of things I'm going to bring into this discussion. One is that that interest rate that the bank economists and the bond traders in the markets more generally are predicting by December 2024 is not unrealistic, you're right. That market does tend to preempt what will happen and in many ways with the cash rate. If economic circumstances change, that number would also change. In other words, if the economy started to slow down or the let's say fiscal policy was tightened remarkably for whatever reason, and that was crunching the economy, that would change. These are very fluid numbers, as first thing I'd point at. A lot can happen of course between now and the end of 2024.

The second thing is the Reserve Bank is not sitting in isolation deciding that it's going to put rates up at a uniform rate for a certain amount of time just to get back to something that it considers normal. It will watch the data very closely every month, of course, ahead of its interest rate board making decision time. It will assess the economy accordingly, and if it sees too many households starting to feel the pinch, then my bet is that it would take its foot off the brakes. Because at the same time, we'd probably be seeing pressures on wages and inflation start to [inaudible 00:41:06]

The third thing I'd point at is that we are in a very unusual times in the sense that the cash rate is 0.1%, as we've said a couple of times. That is an exceptionally low-interest rate. Essentially doesn't cost any money to borrow money at the moment, and that it's generally not sustainable in an economy, which is actually recovering as quickly as ours is from COVID. It isn't suitable although it's painful for some households to hear this, of course, it isn't suitable that money is this cheap at the moment, because essentially, what would and is we'd still get those continued renovations happening and people would still go out and bid for highest prices and they'd push them up, and that's not where we want to be either.

We need the Reserve Bank in some ways to be cooling the economy from that point of view, although acknowledging of course, that they don't directly target house prices. Another point I'd make is that households are sitting on savings that they've basically never seen before, because of the money that the government put into the economy through the COVID two years. Lots and lots of government payments there, and people weren't spending them because number of reasons, they were feeling a bit cautious. They couldn't spend them on services, and the Treasury will say this, we essentially wanted to put more money into the economy than COVID two out. In other words, households and businesses are sitting on strong balance sheets.

Another point I'd make is that, and this is straight from Governor Lowe at the Reserve Bank, households are sitting well ahead on their mortgage rates. In other words, they don't necessarily need to be increasing their mortgage repayment straight away. They have some time to adjust to those higher rates because most households, I think it's about two years ahead on their payments. In other words, the average household, then, of course, this is not the same for everyone, but the average households sitting pretty right now, they've got good savings. They're ahead on their mortgage repayments. They've had it pretty good because of the government payments that have been going into the market and so increasing interest rates should be able to be handled fairly well by most households. I think in the position that they're not, or when the case comes that they're not, the Reserve Bank would act accordingly, and the Reserve Bank, of course, is not going to deliberately crunch the economy. They've done that in the past and they've learned their lesson. They will be taking it easy.

Ross: Well, let's talk about when they did that in the past, because they did do that and it created a situation in the Australian economy that, well, to put it a different way. One of my economics professors at university used to say the only thing that caused the famed economist Keynes to drink too much wine was stagflation, because he couldn't find any simple answers to the concept of stagflation, which was high inflation and high unemployment. That's the situation that you just described before that the Reserve Bank previously, once in the 1970s, which, unfortunately, I do remember, they caused stagflation, and everybody sat around for years going "I don't know what to do. I've got no idea". We've dug a hole and we were a listless, aimless economy. Do you think that that could happen?

Cherelle: Look, it is the stuff of nightmares because as you said, the normal policy tools don't work and Keynesian theory starts to unravel when you've got stagnation. Look, I would say that there's not a 0% possibility that this doesn't happen, and the reason for that is often stagflation is occurring because there are supply shock in the economy, which is lifting prices, and that is what we've got at the moment. In other words, we've got an oil price spike at the same time, well, I'll go back on that. We have an oil price shock at the moment and that's causing higher prices. If for whatever reason the economy was to slow down at the same time, then we'd be in a stagnation situation.

The thing is at the moment, of course, the economy isn't slowing down. If anything, it's going along at a pretty reasonable pace and so as long as that continues, and of course, we avoid the stagflation situation. You'd have to put a low probability on it, so I'd say less than 5%, but you certainly wouldn't say no probably, but of course, the central bank's policymakers, we've learned from the past and hopefully, it is something that we can avoid going forward.

Ross: I think that if there's $1.3 trillion worth of home mortgages, both homeowner and investment mortgages out there, and you put up interest rates 1%, and that equals additional interest payments of $13 billion. That's going to put a big, big dent in the economy in terms of spending goods and services. You take $18,000 out of someone's bank account for one year, and psychologically, there's this thing, which is the stuff of another podcast called the wealth effect. Everybody feels so fantastic. My house has doubled on value. I'm an electrician. I'm earning the same amount of money as my local GP. I'm going to go and buy a new Ford Ranger because they look good. Life is wonderful They're suffering what's called the wealth effect.

All of a sudden you say, okay, give me $18,000 a year straight after tax. That hurts. Psychologically, that changes the game. Do you think that that can happen?

Cherelle: Look, the problem is it doesn't happen as an $18,000 payment out of their budget. It would be to those very clever people who sit there and budget and work it all out, but the average punter I'm guessing doesn't do that. It also comes gradually so you don't lose the $18,000 all at once. It's a series of slow interest rate increases. They're very well flagged, I would say as well. I think most households would be aware that they're coming and they need to start adjusting slowly.

As I said, the fact that we've actually financially anyway, had it pretty good for the last two years. Importantly, that pretty much everyone that wants a job has got one, that's hugely I think means that we won't feel as bad as you might in that situation where we just take $18,000 out of someone's household budget for the year, but the monetary policy is trying to do just that. It is trying to slow the economy and taking money out of people's pockets because they have to pay more on the mortgage. It shows up, there is no doubt about it.

Ross: Cherelle, now we get to the fun bit of the podcast. This is when you, as our first female economist, gets to explain the concept of inflation through a hamburger, and we do this because everybody relates to hamburgers. If we hold up a hamburger and we say we've got inflation, the inflation that we're talking about today, tell me the effects on the hamburger and why.

Cherelle: Okay, well, I'm a bit of a Friday night takeaway person. I'm usually pretty exhausted by the end of the week and cooking for myself, the kids, it's no fun, so I'm thinking about the takeaway. I'm thinking about the hamburger. I'm driving to the hamburger joint with my family, and I've noticed that the price of a hamburger has gone up from $6 to $7, because beef prices have gone up and been talking about some of the reasons for that. The problem is of course I haven't had a pay rise and so I look back at my two kids in the back of the car, and I think, "Ooh, how are we going to get around this problem?"

I work it out in my head and I realize that I can really only afford three hamburgers, not four hamburgers. I can't afford chips for everyone so I'm telling my youngest that they don't get a hamburger. They can only have the chips and that the reason why is inflation. They may not like that, but that's my economic explanation.

Ross: I think that's fantastic. How old are your children? Maybe they can start introducing the word inflation at school.

Cherelle: I've got 12-year-old twins. They do like to sprout back economics at me.

Ross: I'll be using that against you.

Cherelle: Indeed, indeed. That's right.

Ross: Cherelle, thank you very much for demystifying inflation for us, you've done a wonderful job. Enjoy your career at EY, they're a terrific firm.

Cherelle: Thank you.

Ross: I'm sure you'll be able to help all of their clients understand the importance of economics, which is probably the Burgernomics podcast's mission is for people to understand what a fantastic social science that it is. If more people understood it, more people could feel more empowered about their own lives. It's not something to feel threatened about. Inflation is something that I feel is going to start to make people feel uneasy and you, with your descriptions, will make them feel not as uneasy as maybe they would've because now they understand it better. Thank you very much.

Cherelle: No. Great. Thank you. Here's to all those female economists that you're going to have in your podcast of the future because there's many good ones out there.

Ross: Well, I'm looking forward to having lots and lots of them, because yes, I think it's-- I don't know if you know, but the Reserve Bank did a recent study where they basically said that a lot of people aren't studying economics and the female component is falling away quicker than the male component, which I think is a real shame. I really want to courage females to look at economics, it's just a way you can take and change the world. If it's financial markets, if it's sustainability, carbon, any area that you want to in life, economics can make a positive contribution. If you want to change the world, economics is the way to do it.

Cherelle: Indeed Absolutely, it is. It's not all about share markets and bond yields. As you say, there's many applications for economics and we tend to find that women are more interested in the types of careers where they can really do some good in the world. If you want to do some good, then get some economics under your belt I say.

Ross: Absolutely. Thank you very much for joining us.

Cherelle: Pleasure. Thank you for having me.

Ross: My thanks to those who made today's podcast possible. My guest, Cherelle Murphy, EY's Chief Economist for Oceania. I really enjoyed Cherelle's balanced viewpoints, allowing everyone to better understand the factors at play with inflation, especially as it is a topic that generates strong opinions. Also, thank you to Ology Creative for their design, inspiration, and Burgernomics' new marketing and media partner, Sue Tonks from Oliver & York, who due to our growing audience, are providing social media and public relations support for the Burgernomics podcast.

Burgernomics has some fascinating topics coming up that we economically demystify, exposing the reality that will affect you. Electric cars, net carbon zero, and Liberal versus Labor, who will make you wealthier? So you don't miss out, please hit the Burgernomics subscribe button on your podcast channel and follow Burgernomics podcast on Twitter, Instagram, and LinkedIn.

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