Inflation and the carbon tax

Lamenting Australia's lack of a monthly reading of inflation, in 2002 I approached Professor Don Harding and Dr Lei Lei Song (then working at the Melbourne Institute) to see if it was possible to produce a monthly gauge of inflation for Australia. 

After a few months of investigation and testing, we went ahead and created the TD-MI Monthly Inflation Gauge.

A decade on, and the Inflation Gauge has been remarkably accurate in its efforts to pick turning points in the official Australian Bureau of Statistics data. It has outperformed the expectations that Don, Lei Lei and I had when we set it up. The average error in the annual inflation rate measure by the monthly Inflation Gauge versus the ABS CPI is less than 0.1 percentage point.  

Fast forward to the July 2012 reading for the Inflation Gauge and it was surprisingly low. 

It rose just 0.2 per cent in July, even though in the month there was the impact of carbon tax induced prices rises for electricity (up 15 per cent) and gas and other household fuel prices (up 10 per cent).  Other price changes were generally low or negative.

My quick calculations suggest that electricity, gas and other household fuel prices together contributed around 0.4 per cent of the monthly rise of 0.2 per cent meaning that without the carbon induced one-off price changes, the inflation gauge would have fallen 0.2 per cent in July.  The RBA has made it clear that it will discount the one-off impact on prices from the carbon tax when judging monetary policy settings.

The rise in electricity and other utility prices appears to be close to Treasury estimates. This is encouraging in that so far, there are no nasty shocks.

No doubt there are some lags from the introduction of the price on carbon and the full effect on inflation, but for now, it seems that flat or falling prices for goods and services with little or no carbon price impact will see the overall inflation rate stay incredibly low.