Inflation took a surprising and unwelcome jump in Australia in the final months of 2025. After peaking at almost 8% year-over-year in late 2022, inflation rapidly declined – reflecting both the repair of supply chains after the pandemic, and the chilling effects of 13 interest rate hikes from the Reserve Bank of Australia (RBA). Within two years, by end-2024, inflation had fallen back below the RBA’s 2.5% target.
The RBA then began to cut rates, but more slowly than most other global central banks: just three cuts in 2025, for a total of 0.75 percentage points. Those cuts supported a modest pickup in economic activity. But with GDP growth of barely 2% last year, employment growing just 1%, and official unemployment above 4%, it’s not credible to claim the economy is running ‘hot’.
Déjà vu All Over Again
Now, after the surprise jump in inflation at end-2025, the RBA is reversing course. Year-over-year growth in the Consumer Price Index accelerated to 3.8% in December. The RBA responded quickly with a quarter-point rate hike on 4 February, taking the cash rate target back up to 3.85% (one of the highest among major industrial economies). Weary Australians fear the start of another painful episode of rising debt charges, unaffordable mortgages, and job insecurity.
What’s gone wrong in the battle to stabilize inflation in Australia? And can the problem be solved by the RBA once again pulling out its big interest rate hammer?
Conventional narratives about inflation, and its remedy, are being loudly reasserted in the aftermath of the RBA hike. The standard storyline is that the economy is running ‘too hot’, and aggregate demand has outstripped the capacity of the economy to supply that demand. Business lobbyists recite cliches about excessive wage increases, disappointing productivity, and bloated government spending – trying to shift blame for inflation onto the backs of workers.
This is a vital moment to remind the RBA and other policy-makers of key errors they made in responding to the initial burst of post-pandemic inflation. Those errors included:
- Assuming inflation is caused solely by excess demand (with no consideration for the role of supply constraints in generating inflation).
- Ignoring the distributional consequences of inflation, and the fact that certain vested interests profit mightily from inflation (while most others suffer). Inflation does not occur autonomously, but rather is the outcome of deliberate actions by those vested interests.
- Relying single-handedly on higher interest rates to attack inflation (regardless of its causes or distributional consequences), instead of using a more diverse and targeted set of policy responses.
The one-sided and class-blind approach followed by the RBA in the post-pandemic period caused considerable harm to the well-being of workers, households, and government finances. That harm has not yet been repaired, even as the RBA embarks on another tightening cycle. This article will provide a deeper analysis of the nature and composition of the recent uptick in inflation, and propose a more nuanced and targeted anti-inflation response this time around.
Measurement Issues
The RBA boosted interest rates quickly after December’s jump in the ABS’s new monthly inflation measure. That monthly measure became the official inflation indicator only in October. It surged from 3.4% to 3.8% in a single month. But the shift to the monthly indicator (replacing the previous quarterly index) raises major methodological issues that the bank should have considered more carefully before pulling the trigger.
The monthly index has been published on an experimental basis for only 18 months. It is exceedingly volatile, as a result of huge month-to-month fluctuations in many components. And because the series is new, there is insufficient historical data to perform normal seasonal adjustments (as is common practice in other countries). This means that even large single-month changes in the index cannot be reasonably interpreted as signs of an underlying trend – yet that is what the RBA did.
Figure 1 illustrates the annualized inflation rates implied by monthly changes in the new CPI, since it inception in mid-2024. Those annualized inflation rates fluctuated wildly: from as low as -6% in May 2025, to as high as +17% just two months later.
Figure 1: Annualized One-Month and Three-Month Inflation Rates, 2024-2025
Source: Calculations from ABS, Consumer Price Index.
The ‘headline’ year-over-year annual inflation rate widely reported in newspapers (and targeted by the RBA) represents the compilation of these rapid fluctuations over the previous 12 months. Monthly changes in that rate reflect both base-year effects (changes in price levels in the year-ago period) and unusual changes in the end period. This statistic says as much about how prices were behaving a year ago, as about how prices are behaving right now.
The choice of lagging period over which inflation rates are calculated is ultimately arbitrary, yet has huge implications for the resulting measure. For example, Figure 1 also illustrates the annualized inflation rate over three lagging months. This approach is commonly used internationally to measure immediate inflation, while smoothing out the extreme fluctuations that bedevil monthly data. This 3-month series is much more stable than the monthly index. In fact, the three-month rate suggests that inflation has been declining since September – not surging.
Another important reason to discount the monthly December CPI is the unusual composition of the price increases recorded in that month. Astoundingly, among the 87 expenditure categories surveyed each month by the ABS in its CPI, just two accounted for almost all (97%) of the increase in the overall index in December. Those were the two measures of prices for holiday travel and accommodation: domestic holidays became 8% more expensive in December alone, while international holidays became 24% costlier in the month. Those two categories fall into the ABS’s ‘Recreation and Culture’ spending category. Those prices reflected peak demand during the December holiday travel season; they will certainly retreat after the summer. Normal seasonal adjustment (which again is not yet conducted on the new monthly CPI series) would have at least partly adjusted for this outsized effect.
Without those huge increases in holiday travel prices, the overall CPI would have increased only 0.003% in December, instead of almost 1%. And the year-over-year increase in the CPI would have fallen to 2.8% (from 3.4% in November), instead of apparently rising to 3.8%. This is a shockingly narrow and fragile basis on which to hammer the national economy with renewed rate hikes – all the more so since those holiday costs will decline in the months ahead. The fact that the whole Australian economy will now be punished because of large but temporary spikes in the cost of holidays is both bizarre and infuriating.
It is worth noting that the RBA has traditionally emphasized a measure called the ‘trimmed mean’ inflation rate, which discards unusually high or low components from the overall basket. The rationale for that measure is to capture underlying trends in core inflation, without being unduly influenced by unusual changes in particular prices. Indeed, the RBA repeatedly cited this measure in 2024 to justify its slowness in cutting interest rates: the trimmed mean measure declined more slowly than headline inflation, remaining above the RBA’s target for several months after headline inflation fell well into it.
The trimmed mean measure of year-over-year inflation in December was 3.3%, in line with previous months, and only slightly above the RBA’s band (it tries to keep inflation between 2 and 3%). When inflation is rising rather than falling, however, use of this trimmed mean measure has been discarded. The RBA lifted rates (and signalled more rate hikes to come) despite the extremely narrow and temporary composition of the December price surge, and despite stability in the trimmed mean. This reconfirms long-time criticisms that the RBA is asymmetric: concerned more with inflation above target than below it, rather than genuinely aiming for that target.
It also reinforces suspicions that the RBA is still guided by the discredited and metaphysical ‘Non-Accelerating Inflation Rate of Unemployment’ (NAIRU). In public remarks just before taking office as RBA Governor in 2023, Michele Bullock stated that unemployment needed to rise to 4.5% (in effect, a NAIRU) in order to tame inflation. Inflation subsequently fell below target with unemployment well below 4.5%, the long-held belief that desirable unemployment must be maintained in order to achieve stable inflation retains its hold over both the RBA and Treasury. That likely influenced the RBA’s pre-emptive rate hike.
False Narratives
Conservative tropes blame wages, productivity, and government spending for the recent inflation. None of these claims are supported by empirical data.
It was certainly impossible to blame wages for the initial outbreak of inflation after COVID. Wage growth was anemic before and during the initial pandemic. Then, after inflation took off after the lockdowns, wages fell behind prices by a cumulative total of 5.6 percentage points by mid-2023 (Figure 2). While the corporate sector captured its highest profits in history (in absolute terms, and as a share of GDP), Australian workers suffered the most significant decline in living standards in a generation.
Figure 2: Real Wage Index, 2019-2025
Source: Calculations from ABS, Consumer Price Index and Wage Price Index.
Wage growth picked up modestly after 2023, reinforced by supportive changes in industrial relations policy. About one-quarter of the post-COVID damage to real wages was gradually repaired by end-2024. Since then, however, wage growth moderated (falling from over 4% in 2024 to under 3.5%), barely keeping up with renewed inflation. Real wages have thus plateaued over the last year, leaving most of the job of real wage repair undone.
Since wage growth has slowed, and real wages remain 4% below pre-pandemic levels, it is mathematically impossible to blame wages for the acceleration in inflation in the last half of 2025. Ensuring that wage growth stays ahead of inflation, continuing the process of restoring real purchasing power, should be a central goal of macroeconomic policy (as suggested by the ACTU).
Business leaders’ moral panic over productivity growth is equally far-fetched. Firstly, productivity depends primarily on the actions and decisions of businesses – like their investments in new capital and research. If productivity growth is too slow, the main responsibility definitely lies with business.
Despite corporate underinvestment, productivity growth has actually regained momentum after the enormous disruptions of the pandemic (a pattern evident in most industrial countries). Real value-added per hour of work in the private sector grew 1.0% over the latest year. If anything, that productivity growth reinforces worker demands for faster real wage growth, rather than legitimating monetary austerity.
In the highly politicized debates over inflation, the loudest conservative complaint today is that higher government spending is supposedly driving inflation. Relentless editorials claim that extravagant public spending is causing economic overheating and thus inflation. There’s no evidence for this claim, either. Public investment actually declined in real terms over the last year (to September quarter data, most recent available), while current public sector consumption grew just 2.6% — almost identical to growth in private household consumption (Figure 3). All other private spending (including dwelling investment, business investment, and exports) grew much faster than government spending.
Figure 3: Components of Aggregate Demand, Year to September 2025
Source: Calculations from ABS, Australian National Accounts, Table 2.
Liberal Senators badgered RBA Governor Michelle Bullock, in an effort to get her to pin the blame for inflation on government spending. The best they could do was get her to acknowledge the obvious fact that government spending is one component of overall aggregate demand (something every student learns in Economics 101); they nonsensically interpreted this as ‘proof’ of the inflationary impacts of government. The same argument applies many times over to private demand – since government spending only accounts for 28.5% of total GDP (the rest being private sector spending).
Clearly, attacks on government over-spending are a shallow attempt by conservatives and business to attack the ALP federal government, and roll back some of its recent initiatives (including wage reforms for care workers, expanded support for child care and aged care, and others). Australia needs more public spending (including to address bottlenecks that have exacerbated inflation, like housing and child care – discussed below), not less.
Supply Matters, Too
The collapse of conservative arguments about excess government spending reveals a bigger failure in the conventional discourse: namely, that inflation is always and everywhere a problem of excess demand. ‘Too much money chasing too few goods’ is the simplistic motto. And it underlies the one-note response to inflation which dominates orthodox monetary policy. If inflation is rising, that is proof spending is too ‘strong’, and must be slowed down with higher interest rates.
This recipe was disastrous when applied to the initial post-pandemic outburst of inflation – clearly not the result of generalized excess demand. Rather, that inflation was clearly caused by other factors: supply disruptions and shortages, shocks in the composition and timing of demand caused by the lockdowns, and profit-seeking by corporations in several strategic sectors (who exploited market power to extract record profits at a time of social distress).
While those immediate pandemic shocks have largely dissipated, knee-jerk unthinking focus on aggregate demand as the perpetual culprit for inflation (and interest rate hikes as the one-stop solution) is still misplaced. What if the problem is inadequate supply, rather than excess demand? In that case, attacking inflation with higher interest rates is not only misguided, it can be counterproductive. By undermining investment and destroying jobs, high interest rates suppress the increases in productive capacity needed to satisfy the normal demands of the economy.
While supply-side problems (and resulting excess profit-taking) are not as dramatic as in the immediate aftermath of the pandemic, it is clear that supply issues are nevertheless contributing to many of the most painful components of current inflation. Figure 4 illustrates the individual spending components recoding the fastest year-over-year inflation in December. Most of these components have experienced supply constraints or disruptions of various kinds, that help explain rapid price hikes, but which will be insensitive to interest rate hikes.
Figure 4: CPI Components with Fastest Year-Over-Year Inflation, December 2025
Source: Calculations from ABS Consumer Price Index.
- Electricity: Household electricity costs were the fastest growing single component in the entire CPI last year, rising 21.5%. The true cost of electricity generation in Australia is actually falling thanks to the rapid growth of low-cost solar and wind power (buttressed by increasingly inexpensive battery storage). Yet electricity prices, which soared in synch with escalating natural gas prices after 2020, remain sky-high. Inflation in electricity prices in the past year reflected the ending of temporary federal and state power subsidies; but those were just a band-aid applied to the underlying problem of profit-driven electricity supply, distorted by Australia’s supply marketing system (in which the cost of electricity is largely determined by incremental supplies from gas-fired plants). The failures of Australia’s privatized, market-driven electricity regulatory regime is driving this inflation – and high interest rates will have no predictable impact on power prices. Instead of papering over the failure of marketized electricity with government subsidies, government should rethink the entire model, and deliver publicly-produced power at cost to Australian consumers.
- Food: People have to eat, no matter the state of the macroeconomy. Food therefore constitutes another important component of inflation (accounting for 15% of total CPI growth over the last year) that is very insensitive to interest rates. Supply disruptions resulting from climate, international trade, and other pressures have been the key cause of recent above-target inflation in food. Global price spikes for coffee, chocolate, and beef are directly traceable to climate disasters. In the case of beef, that has been exacerbated by the gravitational pull of beef exports to the U.S. (where beef supply has shrunk steeply). Meanwhile, tobacco price hikes are directly attributable to growth in federal excise taxes, which economists typically model as an upward shift in the supply curve. Tobacco taxes will increase again this year (for good public health reasons) no matter what the RBA does; it is ridiculous for monetary policy to ignore the impact of fiscal policy changes on measured consumer prices.
- Child Care: Another policy failure driving up supply-side costs is the continuing challenge facing Australia’s early child education and care (ECEC) system. Unlike most other industrial countries, Australia relies mostly on private for-profit ECEC services. Resulting high prices and inadequate capacity undermine the labour force participation of parents (mostly women), and hold back economic growth. The federal government has tried to paper over these failures with increased subsidies to both parents and providers, but the underlying failures of private delivery are still pushing up prices. Conservatives will blame this trend on recent mandated wage increases for ECEC staff, who are still underpaid relative to their skills and the demands of the work. But the actual problem is the marketization of supply for this critical human service.
- Housing: While housing is not among the leading inflationary sectors listed in Figure 4, it nevertheless made an outsized contribution to inflation in 2025 due to its importance in overall consumer spending. Housing makes up 21% of all consumer spending, more than any other ABS category. Housing costs grew 5.5% over the 12 months to December, with all major components of housing cost contributing (including rents, owner-occupied construction, and services). That accounted for almost one-third of the increase in the total CPI. The failure of Australia’s marketized and highly financialized housing model is the crucial reason for the crisis in housing affordability. Higher interest rates won’t fix that, and will likely make it worse: while resale property prices (not included in the CPI) fall when interest rates rise, development of new housing supply is chilled by higher interest costs – making the supply crunch all the worse.
Across all of these key components of recent inflation, the RBA’s narrative that ‘excess demand’ is the sole culprit, and that crushing demand through higher interest rates is the only remedy, is wrong. A more comprehensive understanding of how inflation is exacerbated by numerous supply chain distortions in Australia is needed.
Who Wins, Who Loses?
This more complete analysis of inflation immediately raises the issue of the distributional impacts of inflation. During the initial post-pandemic inflationary burst, the RBA and its defenders stubbornly refused to acknowledge the role of pro-active profit-seeking by major corporations. Companies in concentrated or strategic sectors (like energy, food, construction, logistics, and some manufacturing) took advantage of supply disruptions during lockdowns to extract unprecedented – and deeply unfair – profits. Gross corporate profits surged to their highest share of GDP in history (peaking at over 30%). Instead of taking action to limit that profit-led inflation, policy-makers in government and at the RBA punished the victims – with 13 rate hikes.
After supply chains normalized and shortages were alleviated, corporate profits moderated – though they are still high by long-run historical standards (currently running at about 25% of total GDP). And while the general problem of profit-taking is currently less severe than in 2020-2023, in certain segments (which have been important in recent inflation) those profits still need to be acknowledged and regulated.
Corporate profit data for the last quarter of 2025 will not be reported by the ABS until March. But there were already signs in September national accounts data of a pickup in profits: total before-tax corporate profit grew 5.2% in the September quarter alone (as price increases quickened). In several of the sectors associated with recent inflation (including accommodation and food service, transportation, utilities, and recreation), profit growth in 2025 was disproportionately strong.
Measures to address undue profit-taking in strategic or concentrated sectors should thus be a central component of future anti-inflation strategy. Obvious candidates in this regard include energy (with measures to limit domestic natural gas prices and their flow-through impact on electricity), housing (with rent controls, rapid expansion of non-market housing, and other supply-side affordability measures), and groceries and air travel (with more aggressive efforts to combat oligopolistic profit-taking in these heavily concentrated sectors).
Using the Full Toolkit
This broader analysis of the causes and composition of recent inflation informs a more diverse, flexible, and targeted anti-inflation strategy. If inflation is not solely or mostly due to excess demand, and if deliberate actions by companies to boost profits through higher prices play an independent role in sparking inflation, then a more convincing anti-inflation strategy needs to incorporate measures to boost supply in key sectors, regulate and prevent excess profit-taking, and in some cases directly regulate the prices of essential goods and services. Those efforts would allow the economy to keep growing, with lower unemployment and higher wages, without sparking unacceptable inflation.
Based on the preceding decomposition of recent inflationary pressures, aspects of this more comprehensive anti-inflation strategy should include:
- Direct price regulation in sectors which depend on public regulation, subsidy, or ownership – including electricity, child care, property charges, and transit.
- Controls on rent and property speculation to reduce inflationary pressure in housing, supplemented by ambitious efforts to expand non-market supply of new housing.
- Pro-competition measures to reduce oligopolistic pricing power in key sectors like groceries, airline transportation, and communications.
- Expanding sectoral and industry-wide collective bargaining systems, so that wages can be set in ways that reconcile steady real wage growth with stable inflation – rather than relying on permanent mass unemployment to discipline workers and suppress wages.
The catastrophic experiences of the pandemic and its aftermath, including its large and sustained cut in real wages, should have awakened policy-makers to the inadequacies of standard NAIRU-based monetary policy. Alas, the RBA’s aggressive and premature response to December’s inflation indicates that true believers in this orthodox model continue to set Australia’s policy. The need for a well-defined alternative vision of macroeconomic policy has never been more obvious.
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