The historic policy response to COVID-19 will result in inflation rising faster than the Reserve Bank currently forecasts, CBA says.

Inflation and the outlook for interest rates has been a topical discussion on equity markets through the middle of this year.

And in his latest appraisal, leading economist Gareth Aird dialled in on the marked changes in fiscal policy that have served to fatten up the collective hip pocket of Australian households.

‘Unchartered territory’

It wasn’t until major governments across the globe pledged to cover for the economic disruption caused by COVID-19 that the calamitous stock sell-off in March 2020 abated.

It took some doing; from a projected FY20 surplus of $5bn, the Morrison government flagged an FY21 deficit of more than $200bn in FY21 (the iron ore boom helped it finish $134bn in the red).

If one “takes a step back” to look at how it happened, Aird says, they would see we are now in “unchartered territory” concerning the policy interconnection between the government and the central bank.

Specifically, the transfer of wealth from the government to households has been “indirectly funded by the central bank through money creation”.


One fallout from the COVID-19 policy response is that it ignited debate around Modern Monetary Theory (MMT), where government spending is financed directly by a central bank.

As Aird noted above, Australia’s government funding has been “indirectly funded” — where the RBA buys government bonds in the secondary market.

That’s not the same as buying them directly in the primary market.

But in practical terms, the post-COVID paradigm has “blurred the distinction between fiscal and monetary policy”, Aird said.

Since March 2020, the RBA has bought $236bn worth of Australian government bonds, which is “not a whole lot less” than the government has actually issued, Aird said.

“Conceptually the RBA prints money, which through an intermediary ends up in the government’s hand,” Aird explained.

The result is that growth in Australia’s broad money supply has comfortably surpassed growth in credit.

In addition, that money supply has travelled directly into household bank accounts through government transfer payments.

For Aird, those two factors form the central components of CBA’s thesis that the COVID-19 policy response will flow through to higher inflation.

Inflation outlook

In July 2020 when the COVID-19 pandemic was still raging, RBA governor Philip Lowe gave a speech where he poured cold water on the MMT concept, arguing there’s “no free lunch”.

If government spending was financed directly through the central bank, it would have to be paid for – either through higher taxes or higher inflation, Lowe said.

Broadly speaking, CBA agrees. But Aird says what’s actually happening on the ground is “very much similar” to the MMT scenario, “to the extent that money creation is financing fiscal spending”.

“And we believe there will be an inflation lift as a result,” Aird said.

While mortgage growth in the zero-interest era has climbed, CBA says Australian households also stepped up their debt repayments to the tune of $4bn per month during the pandemic.

Combined with government payment transfers, CBA estimates that Australia will accrue an extra $230bn in savings by the end of this year.

If households spend around 15% of that war chest next year, it will result in direct consumer spending lift of $35bn. “The risk lies with a larger number,” Aird said.

As demand-side spending picks up, CBA estimates core inflation growth will consolidate at 2.5% by the middle of 2023.

That’s at the mid-point of the target 2-3% range, and higher than the RBA’s current forecast of 2%.

While maintaining the caveat that risks “are skewed towards a later date”, Aird is holding firm on his view that the RBA will be forced to move on interest rates earlier than it thinks.

CBA has flagged May 2023 as the date when rates will start to rise – “well before the 2024 start date the RBA is signalling”, Aird said.