Is inflation good or bad for our economy?

Inflation has been in the news a lot recently, hasn’t it?

And it seems to be scaring some people, particularly younger folk who haven’t experienced rising inflation before and who are currently finding the cost of the petrol to fill their cars and cost of living, in general, is rising. 

Australia’s current annual inflation rate is 3 per cent, but many countries are now experiencing higher inflation, including the USA where inflation is sitting at 6.2 per cent.

While the media like to talk about the boogie man of inflation hiding around the corner, it should be understood that in a healthy economy, prices tend to go up as demand pushes prices a little higher as suppliers try to create more of the thing that consumers and businesses want to buy.

So basically, inflation is a rise in price levels.

While as a consumer you might not like that, moderate price growth is a sign of a healthy, growing economy.

And, historically at least, wages tend to go up at about the same pace during periods of inflation.

Of course, that hasn’t been happening recently.

On the other hand, low inflation is bad.

Very low inflation is usually a sign that demand for goods and services is lower than it should be, and this tends to slow economic growth and depress wages growth.

In fact, very low demand can lead to a recession which further increases the chance of unemployment.

So is inflation really something to be scared of?

Inflation should be seen as a positive as long as it doesn’t get out of control.

As I said, a moderate amount of inflation is generally considered to be a sign of a healthy economy, because as the economy grows, demand for “stuff” increases.

On the one hand, inflation makes cash that you hold in the bank or under your mattress less valuable tomorrow.

And at present, the concern is that rising inflation may lead to high-interest rates from the Reserve Bank, and no one is really looking forward to that.

We know that the Reserve Bank would like inflation to consistently sit around 2 to 3% per annum and so currently their interest rates are intentionally low – at stimulatory levels to speed up our economy and grease the wheels of industry.

But when inflation rises, and if it is accompanied by consistent wages growth, the Reserve Bank will eventually raise their interest rates from their loss to military levels to neutral levels which might be 1 to 1.5% higher than the current rate

But higher rates of inflation have some benefits

1. Rising inflation will reduce the impact of ballooning government debt.We know the Australian government spent up big to get us through the last couple of difficult years of the pandemic and to minimise the economic impact of the lockdowns and avoid the high unemployment rates that were initially predicted. It seems that the government has done this job well, but this came at a cost with Australian government debt now heading towards $1 trillion, double what it was before the pandemic.So, I can imagine the government would likely be pleased to see their debt burden decrease when inflation causes the future value of their debt repayments to decrease.

2. Similarly, inflation works for property investors and other businesses with large debts.On the one hand, rising house prices decrease loan-to-value ratios and increase investors’ equity.On the other hand, investors will be able to pay their future mortgage repayments with dollars that are not as valuable.At the same time, property investors will benefit from higher rentals that usually come along with higher inflation.

The bottom line

I’m not really worried about inflation, and I can’t see it causing a collapse in the housing market as the property pessimists are predicting.

I know that some homebuyers and investors have borrowed as much as possible to get into the market and will be stretched if interest rates rise because of rising inflation.

But remember… banks have already put a buffer in place for borrowers and allowed for interest rates to rise by 2.5 to 3% before these borrowers fall into stress.

And currently, the average Australian family is wealthier than they ever have been, and many are well ahead in their mortgage repayments.

In the past when interest rates rose the typical Australian family would slow down their discretionary spending and “Maggi Noodles” rather than missing a mortgage payment or giving up their house, and it’s unlikely to be any different this time around.

My advice: if you’re a property investor, stop worrying about inflation and use it to your advantage.

ALSO READ: Interest rates and inflation: where are they heading?