On Budget night, Treasurer Jim Chalmers claimed that the Government’s measures would reduce inflation. Budget Paper No. 1 also makes the following claim about the Consumer Price Index (CPI):
The Government’s measures to deliver cost-of-living relief will directly reduce the CPI in 2023-24, and are not expected to add to broader inflationary pressures in the economy. These measures are expected to reduce inflation by ¾ of a percentage point in 2023-24.
Where do these claims come from? Are they plausible? Will these effects persist beyond 2023-24? Will the measures have other implications that might be less desirable? Will these measures provide support to the Reserve Bank of Australia (RBA) in curbing inflation without tipping us into recession?
How will the Government “directly reduce the CPI”?
Budget Paper No. 1 states:
The Government’s Energy Price Relief Plan is expected to significantly lower inflation in 2023-24 by around ¾ of a percentage point.
This plan is not new, being announced back in December 2022.
What are the details of this plan? The headline claims are that the measures will reduce household electricity costs by 25% and gas costs by 16% over 2023-24. In the basket of goods and services used to calculate the CPI, electricity accounts for 2.22% while gas and other household fuels accounts for 0.98%. These weights and the forecast reductions of 25% and 16% yield an overall forecast reduction in the CPI of just under three-quarters of a percentage point.
The plan to reduce household electricity costs includes two components:
- A temporary cap on black coal prices of $125 a tonne for electricity generators. This cap will be funded in part by the Commonwealth, hence its relevance to the Budget. Treasury estimates this will reduce household electricity price increases by 13 percentage points.
- Direct electricity bill relief for lower income households of up to $500 and small businesses up to $650. This will also be funded in part by the Commonwealth (up to $1.5 billion). Presumably this bill relief contributes the remaining 12 percentage points of the overall 25% impact.
Average expenditure on electricity by households in 2021 was $1,645. For households receiving the full $500, this is roughly a 30% reduction. Better off households are expected to receive less or nothing. The specific details differ by state.
By providing this electricity bill relief to households via their electricity retailers rather than via direct payments, the measured CPI will fall, as electricity prices paid will be lower.
Precisely how black coal price caps for electricity generators will reduce household electricity costs is not described in the Government’s press release or in legislation. It seems a long distance from coal price caps to lower household electricity prices, so Treasury’s forecast is likely based on a tonne of assumptions.
The forecast reduction in household gas prices is based on a cap of $12 a gigajoule on wholesale gas prices in the Eastern states. The legislation focused mostly on the legal requirements allowing the Government to cap wholesale gas prices. The link to household prices is not described in any detail, and the effect of the cap on domestic gas supply is still unclear.
Will these effects persist?
The direct household electricity bill relief is expected to be temporary. If the same bill relief is not provided in the following year, the downward impact on the CPI in 2023-24 of 12 percentage points will be reversed, raising the CPI in 2024-25.
If the cap on black coal prices is lifted in a year, as foreshadowed, will household electricity prices also simply bounce back up? No doubt we hope that the current turmoil in global energy markets will be over soon, but the war in Ukraine seems no closer to a resolution.
The cap on wholesale gas prices is not due to be re-visited until mid-2025. This leaves open the potential for the cap to remain longer-term.
Any unintended consequences?
Lowering household gas costs in the near term may well slow down movements away from household gas usage. This may be less than ideal given concerns regarding the negative effects of cooking inside with gas on health. Electricity bill relief may also lower the benefits of reducing reliance on home heating. Direct payments may have allowed households to purchase products that lower electricity usage.
Capping black coal and wholesale gas prices may also slow substitution away from these sources of electricity generation. This may in turn slow momentum in the uptake of renewables.
Does the Budget lower inflationary pressures?
The Government claims that their “measures … are not expected to add to broader inflationary pressures in the economy”. These measures increase government spending by around $2 billion. Electricity bill relief and compensation to energy generators for black coal costs above $125 per tonne is “additional”, unless it has been offset with spending reductions elsewhere in the Budget.
More generally, does the Budget overall add to inflationary pressures? In simplistic terms, budget deficits are expansionary, stimulating the economy with more government money going in than coming out. Budget surpluses are the opposite. A balanced budget, as this one is projected to be, may thus not “add” to inflationary pressures.
Some have argued that with inflation currently well above the RBA’s target band and unemployment at historically low levels, a budget surplus (reducing demand in the economy) is necessary. Others have argued that the Government should have provided more relief to households on government benefits.
Will it help the RBA?
The RBA is concerned with bringing inflation back down to its target band of 2-3% without pushing the economy into recession. The eleven cash rate increases over the past year have moved monetary policy from extremely expansionary (0.1%) to something much closer to neutrality (3.85%). The last time cash rates were this high was 2012, when inflation was coming back down into the RBA’s target band and unemployment was above 5%.
The RBA is particularly concerned about inflationary expectations. If they remain elevated, the job of returning inflation to the target band gets that much harder, and interest rates will need to be higher for longer, raising the probability of recession. Will these measures keep a lid on inflationary expectations? While they may help, household and business energy costs are still predicted to rise, just perhaps not by as much as they may have without these measures. The temporary nature of the electricity bill relief in particular may not tip the RBA scales much at all.
The RBA is trying to walk a tightrope, and the Government is cautiously holding its breath. So are we.
Other Budget Forum 2023 articles
The Costly and Unfair Stage 3 Tax Cuts Will Undermine the Progressive Income Tax and Worsen Inequality, by Kathryn James, Guyonne Kalb, Peter Mares, Miranda Stewart and Roger Wilkins.
Inflation Forecast, Fiscal Policy and Personal Income Tax Rates, by Chris Murphy.
Financial Support for Those on Low Incomes, by John Freebairn.
Stage 3 Tax Cuts and JobSeeker – A Slightly Different View, by Andrew Podger.
Equity Is Hard to Achieve When Unfairness Is Baked into the System, by Robert Breunig.
A Small Investment in the Budget With a Big Policy Return? By Nicholas Biddle.
Labor Could and Should Have Gone Stronger on the Petroleum Resource Rent Tax, by Rod Sims.
How Removing Parenting Payments When Children Turned 8 Harmed Rather Than Helped Single Mothers, by Kristen Sobeck.
Straightening Out the Super Tax Breaks Debate, by Brendan Coates and Joey Moloney.
The Priorities of Australians Ahead of Budget 2023-24, by Nicholas Biddle.
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