Workers in Australia have suffered considerable economic losses as a result of accelerating inflation since the onset of the COVID pandemic. Reaching a year-over-year rate of 7.8% by end-2022, inflation has rapidly eroded the real purchasing power of workers’ incomes; average wages are currently growing at less than half the pace of prices. Now, severe monetary tightening by the Reserve Bank of Australia (through higher interest rates) is imposing additional pain on millions of workers. Tens of billions of dollars of household disposable income are being diverted away from consumer spending, into extra interest payments made to banks and other lenders. Most ominously, signs of macroeconomic slowdown from higher interest rates portend job losses and even greater income losses in the month ahead.

The pain experienced by workers through this inflationary episode contrasts sharply with an unprecedented upsurge in business profitability at the same time. Additional profits resulted from businesses increasing prices for the goods and services they sell, above and beyond incremental expenses for their own purchases of inputs and supplies. This dramatic expansion of business profits (taking gross corporate profits to almost 30% of national GDP, the highest in history) has been mostly unremarked on by the RBA and other macroeconomic policy-makers. They have focused instead on the supposed risk of a ‘wage-price’ spiral. However, new empirical evidence confirms the dominant role of business profits in driving higher prices in Australia – not wages. This suggests the focus of monetary policy on wage restraint is misplaced and unfair.

Major findings:

• As of the September quarter of 2022 (most recent data available), Australian businesses had increased prices by a total of $160 billion per year over and above their higher
  expenses for labour, taxes, and other inputs, and over and above new profits generated by growth in real economic output.
• Without the inclusion of those excess profits in final prices for Australian-made goods and services, inflation since the pandemic would have been much slower than was experienced in practice: an annual average of 2.7% per year, barely half of the 5.2% annual average actually recorded since end-2019.
• That pace of inflation would have fallen within the RBA’s target inflation band (equal to its 2.5% target plus-or-minus 0.5%). Even within the RBA’s own policy rule, therefore, current painful interest rate hikes would be unnecessary.
• A second scenario considered below allows for modest nominal inflation in unit profit margins, consistent with the RBA’s 2.5% target – once again, above and beyond the costs of other inputs (including labour and taxes) and the growth of profits due to expanded real output. Even in this scenario, inflation would have averaged just 3.3% since the pandemic, only slightly above the target band, and current harsh interest rate changes would again have been unnecessary.
• Analysis of the income flows associated with excess inflation since end-2019 confirm the dominance of corporate profits in the acceleration of inflation since the pandemic. Excess corporate profits account for 69% of additional inflation beyond the RBA’s target. Rising unit labour costs account for just 18% of that inflation.
• The distributional dimensions of post-COVID inflation (falling real wages, falling labour share of GDP, and record corporate profits) are completely opposite from the experience of the 1970s (when real wages rose, the labour share of GDP increased, and corporate profit margins fell). This historical comparison confirms that fears of a 1970s-style ‘wage price spiral’ are not justified. Instead, inflation in Australia since the pandemic clearly reflects a profit-price dynamic.