It’s obvious then that a saver who earns 1% when inflation is 6% is falling behind by 5% in real terms. When interest rates go up, that same saver earning 4% will feel as if their income is getting a lift, because it has more than doubled the impact of inflation. “It would appear the pendulum is coming back to savers as interest rates move higher,” he added.

But who is this trend helping borrowers or savers? It is a bit of a cliché to say that governments can “inflate away the debt” but there is an argument that they are able to do so as they repay their maturing bonds with money that is worth less in the future compared to when they borrowed it. In other words, the debt costs less of the government’s revenue, as inflation erodes the value of the borrowing.

So far so good. But what about households?

A friend asked me last week whether, because he is a borrower with a big mortgage, he should be rooting for high inflation. That is, is inflation ‘inflating away his debt’? So in theory, if he is paid a wage that rises with the CPI, how much he owes hasn’t changed, even if he’s earning more. My initial instinct was to stick with the conventional logic that high inflation is good for borrowers.

But here's the catch. It was bringing about higher interest rates on his mortgage through rising inflation, but there was no such pay increase as a buffer against CPI. So how is his debt to be 'inflated away' when it is already costing him more and he doesn't earn the salary to do so. His debt is how, exactly, decreasing? How can someone with a big old mortgage be happy about inflation when all he sees is mortgage pain?

Good question. If governments have 'inflated away their debt' before, why isn't the same logic applicable to households now? It was becoming a self-fulfilling circle, a circular path of confirmation bias, and so I asked Shane Oliver from AMP that very question, my head spinning. He replied:

“Governments certainly did inflate their way out of high debts that lingered after the conclusion of World War 2, as post-war inflation along with robust economic growth whittled down the real value of their debts as a ratio to GDP. But this was an era of relatively low bond yields. And if bond yields had gone up in line with inflation, then governments would have been in trouble.

It's harder for individuals. This is in the early stages of the inflation take-off in the first half of the 1970s when wages growth was way ahead of inflation (rising to near 18% in 1974 but wages growth was then 25%) and lagging interest rates behind inflation. And people didn’t have as much mortgage debt back then (relatively speaking, in terms of how much debt compared with the amount people were paid). My parents did well back then.

But right now we have an unfortunate perfect storm of high mortgage debt, surging interest rates and wages growth that’s lagging behind the rate of inflation.” Wages are nowhere near matching the increase in interest payments on mortgages. So it may well be that the real value of the debt is falling in the same way that consumer prices are rising more than the real value of the debt, but wages growth is so slow it doesn't help people with a mortgage.

So I don’t think that old view of ‘inflating the debt away’ applies these days to those with a mortgage.”

And savers during the current period of inflation, how does it compare with the past? One recent chart for the US comes from JP Morgan as shown below. In the 1980s, high inflation forced the Fed to jack up rates quickly, and the chart reflects a saved community of people who were paid higher rates of interest than the inflation level (the grey bars). In the 1990s and even the 2000s, deposit rates generally tracked inflation.

But then, as yields on bonds fell after the GFC, the inflation rate began to exceed the yield on bonds. That was the situation in both the US and Australia through the 2010s and into 2020 as Covid struck. The yields of bonds and bank deposits dropped close to zero. After adjusting for inflation, true savings yields dipped below zero.

So there you have it: Over the past 40 years we’ve had high inflation and high interest rates, low interest rates and low inflation and now we have low and rising interest rates and high inflation.

So which is better for families? After all, savers prefer to earn higher rates even when inflation is running hot. Retirees griped about 1% rates when inflation was 2% and would likely love 4% rates when inflation is 6%. Borrowers do not like rates at 4% high inflation rather than 2% low inflation, because wages do not increase to ‘inflate away their debt’.

Savers are better off in today's inflationary environment than are mortgage holders.

On Tuesday this week, the Reserve Bank indicated borrowers would face even more pain:

“The board judged that it was appropriate to hold the stance of policy unchanged at this meeting,” the governor said. “The board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time.”

Today (Thursday), at 1pm, the Governor of the Reserve Bank will speak to the Anika Foundation on Inflation and the Monetary Policy Framework. Each time he speaks, the media analyses every word for a clue regarding future policy decisions. Nor does the fact that such depth of analysis has been deceptive in the past dampen the enthusiasm.

We have now had 5 months in a row of rate rises four times 0.5% and this time 0.25%… Every time, the news programmes wheel in the same footage of young couples with massive mortgages who will be forced to buy frozen vegetables instead of fresh. They could re-run those stories from months ago.

Who are the lenders and the borrowers, the winners and the losers? The ABS reports that the median age of all Australian residents is 38.4 years, and that:

Those aged between 20 and 44 years comprised 37 per cent of the combined capital city population, compared with 30 percent of the rest of Australia's population.

The population of Australia's capital cities also had a lower proportion of people aged 55 years and over (26%) compared with the rest of the nation (34%).

Nearly 80% of members of SMSFs are aged over 50 and their balances are much higher than those of members who are under 50 years old. Some 75% of retirees own their home, and the younger generation of Australians still crave the Great Australian Dream. But it’s probably correct to say that young people are the borrowers (or would-be borrowers) and old people are the savers. Different people respond to it in different ways, depending on their resources, stage of life and age, and we know from the Intergenerational Report that this chart will get fatter at the top (for example, 5 per cent of Australians are projected to be over 85 by 2050).

The youngest of the so-called Silent Generation (they’re anything but!) are aged 77, and with post-war values of thrift and owning one’s own home, most are in that 80-100 year old bracket where health, volunteering and estate planning are going to predominate. Today they are 58-76 and retiring in the thousands per week, and some anticipate living another 30 years, and would rather live out of income than off capital. Home loans are either small or finished.

We sometimes forget that the oldest of the Millennials, those whippersnappers are in their 40s, and plenty have big mortgages. This is the generation that has seen the greatest hit from rising rates on loans. They are those couples, the 26- to 41-year-olds we see on the news when the rates soar. And some of the freedom-loving, resourceful and independent Gen Xers can now retire, so there is a mix of fortunes there.

A reason why the Reserve Bank should resume its rate hike cycle is, consumer confidence, spending and believe it or not, unemployment is all at historical highs. Indeed, Ross Gittins of The Sydney Morning Herald reckons that we have exceeded a tipping point and that so many long-term unemployed folk have been re-linked to the workforce that Australia will have a permanently lower unemployment rate. He wrote:

“It is lower than it would have been had the program never been enacted,” Allen said in e-mailed comments on behalf of the Secretary of Labor. “By providing work.” The program is putting 125,000 “long-term unemployed” into the working world, and as such, has lowered the floor under the unemployment rate by about 1 percentage point. So even if the economy falters in coming months or years, the unemployment peak, no matter how high, will be perhaps one percentage point lower than it otherwise would have been. That brings us closer to a state of full employment that is more intuitive to the average person, who believes there has to be such a thing as full employment and that it surely must involve unemployment of roughly zero.

Longer term, we need to rejigger our mental assumptions regarding a return to low inflation in 2023 after a year of agony. Despite its assessment that.

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