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Over the past three years, consumer prices in Australia have risen at an average annual rate of 5.3% – the fastest increase over a three-year period in more than 33 years. It’s an almost identical picture in New Zealand, where the 5.5% per annum increase in consumer prices over the past three years is the highest over any three-year period in the past 34 years.

Put differently, no-one under the age of 50, on either side of the Tasman, has experienced inflation as an adult as fast as over the past three years.

Reserve Bank of Australia (RBA) governor Michele Bullock said in a speech in early September that “inflation causes hardship… for all Australians and particularly for the more vulnerable in our community”.

She went on to explain that it “raises uncertainty and makes it harder to plan for the future”, that it can “distort economic activity, affecting decisions about investment and employment, and ultimately hurting productivity and household income”, and that it can cause “shifts in people’s wealth and spending power”. And, of course, she noted, bringing high inflation down through tighter monetary policy (higher interest rates) “can have long-lasting costs for households through higher unemployment”.

Inflation hits households differently

The costs of inflation – and the costs of dealing with inflation through higher interest rates – affect households differently.

In Australia, for example, prices of so-called ‘essential’ items – housing, food, fuel and power, medical and health care, ground transport, communications and education services – have risen at an average annual rate of 6.1% over the past three years, compared with a 4.3% per annum increase in prices of ‘discretionary’ items.

Since essentials account for a larger share of the spending of lower-income households than of higher-income households, lower-income households are (all else being equal) likely to be more adversely affected by persistent high inflation. They will typically have less scope to reduce spending on discretionary items, or to trade down to cheaper items, in order to make ends meet as opposed to higher-income households. And, they will usually have smaller savings buffers to draw down in order to maintain spending than more affluent households.

Stats NZ Tatauranga Aotearoa’s consumers price index doesn’t provide an official breakdown between essential and discretionary items. But applying the same definitions as used by the Australia Bureau of Statistics (ABS) suggests a somewhat different picture in New Zealand, with prices of essentials rising at a slower pace than those of discretionary items. That’s largely because food, housing, health and especially electricity prices have risen by less in New Zealand over the past three years than in Australia.

Rising interest rates

It’s not just inflation itself that inflicts financial pressure on individuals and families. The measures imposed to fight inflation can also inflict hardship – in ways that differ according to people’s circumstances.

Central banks in Australia and New Zealand – like their counterparts in other advanced and in many developing economies – have responded to the re-emergence of inflation in the aftermath of the COVID-19 pandemic by raising interest rates more rapidly than at any time in the past 30 years.

The RBA raised its cash rate 13 times between May 2022 and November 2023, by a total of 425 basis points, to 4.35%, while the RBNZ raised its cash rate 12 times between October 2021 and May 2023, by a total of 525 basis points, to 5.50%.

In Australia, these moves by the RBA flowed swiftly into the interest rates paid by homebuyers with mortgages, and to businesses with outstanding loans. The average interest rate paid by people with mortgages rose by more than 350 basis points between May 2022 and December 2023, from just under 2.9% to just under 6.4%, while small business overdraft rates rose by a similar margin, from just under 4.2% to about 7.75%.

In New Zealand, the impact of the increases in the RBNZ’s cash rate was muted to some extent by the greater prevalence than in Australia of fixed-rate mortgages; but even so, the average interest rate paid by people with mortgages rose by about 340 basis points, from about 2.85% in late 2021 to 6.25% in mid-2024.

The reliance on monetary policy to fight inflation means that the burden of that fight is borne primarily by households and small business owners with outstanding debt.

In Australia, about 34% of households have mortgage debt outstanding on their own home, and 11% have debt outstanding on an investment property (there is some overlap between these two figures); only about 2% of households had business debts outstanding. Owner-occupier housing debt is highest among households aged between 25 and 44, and to a lesser extent those between 45 and 54. Older households, who bought their homes when prices were much lower, have typically either substantially reduced their mortgages or paid them off entirely. Some of them actually benefit from higher interest rates (for example, on term deposits).

Who is hit hardest?

It's therefore not surprising that younger households are feeling the greatest pressure. This is borne out by the CommBank’s most recent Cost of Living Insights Report, which showed that per capita spending by Australians aged 25–29 and 30–34 declined by 3.5% and 0.6%, respectively, over the year to the March quarter of 2024, whereas per capita spending among over-60s ran ahead of inflation, increasing by 3.7% among 60–64 year olds, then stepping up gradually with age to a 6.8% increase for people aged 75-plus, over the same period.

In the 1950s, 1960s and 1970s it was more common for fiscal policy instruments – in particular temporary surcharges on personal and company income tax or increases in sales tax rates – to be used in fighting inflation. Arguably, that spread the burden of bringing inflation down more widely – and hence more fairly – than relying solely on raising interest rates.

But these methods fell out of favour from the 1980s onwards, partly because of the difficulties getting the necessary legislation through parliament. It came to be recognised that increases in interest rates could be deployed much more quickly. Perhaps it might be time to rethink that view.