Is Australian economy facing a wage-price spiral? 

Highlights

• The Australian economy is currently facing rising interest rates, high inflation, and slow wage growth.
• A wage-price spiral can develop when higher wages contribute to the existing inflationary pressures.
• Australian workers are demanding higher wages amidst ongoing inflationary pressures.

The Australian economy is facing challenges from multiple directions. High inflation, rising interest rates and a decline in real wages have clouded the country’s economic outlook. These factors together have created a highly volatile environment, making the post-pandemic recovery a mammoth task for authorities.

The Reserve Bank of Australia (RBA) started its rate hike journey in May when it raised interest rates by 0.25%. This was followed by a big interest rate hike of 0.50% in June. The process of transitioning to higher interest rates might have been much smoother in the absence of international factors affecting the Australian economy.

The RBA believes that the low-interest rate setting was unsuitable for the highly inflationary environment visible in Australia. Thus, further rate hikes can be expected in the coming months, which could increase households’ burden.

Meanwhile, wages have not grown at par with the rising inflation rate, raising concerns among policymakers. While economic growth remains stable and the labour market is providing the underlying source of strength, a slow wage growth suggests that these benefits are not passed on to households.

Some experts believe that the Australian economy could face a wage-price spiral amid these diverse circumstances. Let us first discuss what a wage-price spiral means:

ALSO READ: Australia's energy woes deliver inflationary shock to RBA

What is a wage-price spiral?

The wage-price spiral explains the relationship between rising wages and increasing prices. Essentially, a wage-price spiral refers to the economic state wherein rising wages contribute to higher inflation in a highly charged economy.

The underlying mechanism of a wage-price spiral is quite straightforward and easy to understand. Workers demand higher wages during inflationary periods, which ultimately leads to them demanding more goods and services. Higher demand for goods and services against no changes to the supply leads to higher prices.

Thus, higher wages often bring price increases with them, which can create more volatility in an inflation-fuelled environment. The macroeconomic theory is a part of the Keynesian framework, and it highlights the causes and consequences of inflation. It is also described as the cost-pull form of inflation.

Overall, the wage-price spiral signifies a perpetual cycle of inflation, where higher wages create upward pressure on prices. The cycle continues until higher wages can no longer be supported.

ALSO READ: Should Australia be worried over World Bank's latest stagflation warning?

Where does Australia stand?

Surprisingly, Australia’s inflation pressures are relatively better than that of many other advanced nations. Additionally, the economy has grown at the rate of 0.8% in the March quarter, as per the Australian Bureau of Statistics (ABS). This was achieved despite major staff shortages and disruptions by Omicron outbreaks during the quarter.

Further adding optimism to the scenario is households’ high savings, which were developed during the lockdowns. These savings have helped stimulate retail spending despite inflationary pressures. Additionally, Australian exporters have also benefitted from rising commodity prices due to the Russia-Ukraine war.

However, wage growth has not matched the pace of inflation. A survey of business conditions conducted by ABS reveals that over a third of all businesses expect to increase their prices by more than usual in the next three months. Against this backdrop, the RBA is also expected to tread on its path of interest rate tightening, putting more pressure on businesses and households.

To combat inflationary concerns, union leaders want wages growth to at least match the rate at which annual inflation is increasing (5.1% in March 2022 quarter). In cases wages do not rise in line with inflation, it would mean that the real wages have fallen in reality.  

But a high wage growth might be extremely damaging for the economy, given the seriousness of the wage-price spiral. Consequently, state governments have come up with rate hikes of less than 5%. But this does not add much real value to households. Concerns loom that a wage-price spiral could build up in the economy if inflation levels are not brought under control.

However, little can be done domestically as most of the inflationary pressures have stemmed from international factors. Though steady consumer demand has helped keep the economy buoyant, a decline in consumer confidence is also visible. Thus, upcoming months will determine if Australia really lands into a wage-price spiral or if authorities will be able to manage inflation in a better way.

ALSO READ: Half a million Aussie motorists to get AU$750 cash rebate amid rising tolls