Inflation is rising around the world, the sting in the tail of the pandemic economic stimulus packages unleashed by governments in 2020. The narrative thus far is that this inflation spike is transitory, even if a little more persistent than first thought. It is expected to moderate as consumer price pressures ease and markets rebalance after the large positive demand shock and surge in consumer spending of the past 18 months.

This appears to be the view at the Reserve Bank of Australia (RBA) and Treasury in early 2022. Australian inflation rose to 3.5% in 2021, lower than the global average of around 4.5% but above the RBA’s target band of 2-3%. The risk is that we could simply be lagging international developments. What will determine whether inflation sustains a lift above the target band will come down to what happens in Australian labour markets, and how businesses respond to rising nominal wage growth.

The setting of both monetary and fiscal policy will be critical over the medium-term. Highly accommodative policy settings, headlined by a near-zero RBA cash rate, appear inconsistent with rising inflation risks. The extraordinary policy settings of the pandemic period must be re-calibrated to the evolving post-pandemic economic environment. Fiscal consolidation, as much as monetary normalisation, will thus be an essential part of reducing inflation risk over the next three years.