How the ‘mindset’ of business could worsen inflation woes

Lowe has pointed out that for consumer prices to keep on rising at these rates in the longer-term, commodity prices would also have to continue rising — which is far from guaranteed. He expects commodity prices will eventually “wash through” the economy.

Even so, much will also depend on how companies respond to rising costs, particularly if they break what Lowe has called a “strong cost-control mindset”.

For years, the RBA has been suggesting that a penny-pinching approach by business was a key reason why wage growth has been so miserable. It has said firms were too worried about losing business to put up their prices, and therefore were also reluctant to raise wages for their staff.

With prices now rising sharply, it’s possible businesses could change their attitude, and start thinking they can get away with raising their prices more aggressively. If prices start rising more generally, at a time when job vacancies are already at record highs and unemployment is at its lowest level since 2008, businesses may also be pushed into paying bigger wage increases.

There’s no obvious data point to measure if this mindset shift is happening, but the RBA will be watching the issue closely through its business liaison program.

But hang on, doesn’t the RBA want wages to go up more quickly?

Yes – Lowe has repeatedly said he wants higher wage growth of about 3 per cent, compared with 2.3 per cent currently, to support “sustainable” inflation. The point is, the RBA wants this process kicked off by solid pay rises in the labour market, rather than from businesses jacking up their prices due to higher input costs.

Why does it matter?

The risk is that if the inflation mindset of business and the community changes too sharply, it will be self-fulfilling. People could start thinking fast price growth is normal, raising the risk of a spiral of rising prices and wages, as occurred in the 1970s and 1980s.

To prevent this from happening again, central bankers like to keep inflation expectations “anchored” at a low level: the RBA’s target band is 2 to 3 per cent.

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So far, there are early signs that the public’s expectations about inflation are starting to pick up – though it’s not that dramatic. Research from National Australia Bank economists has found inflation expectations — including those of the financial markets, consumers and union officials – have lifted to around average levels.

AMP Capital Investors chief economist Shane Oliver says inflation expectations are a bigger problem in the US, but we shouldn’t be complacent in Australia because things can change quickly.

“Beyond the war, it’s probably the biggest risk economies face at present. The longer this continues, the greater the risk that it will become entrenched,” Oliver says.

There is, of course, a certain circularity to all this: the perception of rising prices can be a powerful thing.

Whether the warnings of surging prices eventuate will partly depend on events out of our control, such as the war in Ukraine and its impact on oil and other commodities. But it will also depend on whether businesses change long-standing habits in how they set prices, and pay their staff.

Ross Gittins is on leave.

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