Want to know more about the ‘cost of living crisis’ but don’t know who to ask? We’ve got you covered

Unless you’ve been living under an incredibly huge rock for the past year or so, and you’ve been living there with a good 12-month supply of food and liquid refreshments, then you won’t have failed to notice that the price of pretty much everything is going up, up, up.

Fuel? Up. Milk? Up. Toilet paper? Up. The CD of Shannon Noll’s Greatest Hits? Ok, there’s always an exception to the rule.

But still, on the whole, prices are climbing, and you’ll have no doubt witnessed that in a professional capacity as well as during your weekly grocery shops.

The news headlines scream, ‘There’s a cost of living crisis’! Interest rates are at generational-high levels and the vast, vast majority of us are feeling the pinch.

The question many of us come back to – even if it’s just in our own minds – is: why the hell is this happening?

It seems as if we’ve just got to accept that things are more expensive without understanding why. We’ve just got to accept our mortgage repayments have increased by $1000 without being told how that’s going to help the situation.

So, to save you from asking that ‘why’ question (and let’s be truthful here, most people don’t know the full answer!) we’ve delved into this from the very start.

Strap yourselves in…

Why is Australia in a ‘cost of living crisis’?

Simply put, COVID and Putin. Thanks guys.

“The financial crisis is currently happening because consumer costs (the costs that we pay for goods and services) are up and rising dramatically,” says Derek Sall, Founder and Lead of Life And My Finances.

“For the most part, people’s earnings haven’t increased fast enough to keep up with their inflated costs.”

But why are those consumer costs rising? It’s a supply and demand issue. If there’s an increase in demand or a shortage of supply, prices will rise.

Thanks to COVID, we saw both. Manufacturers struggled to make and ship products due to lockdowns and illness, the supply chain was disrupted and therefore supply slowed.

And post-COVID, people have been keen to get out there and spend money – increasing demand.

That’s why prices are going up everywhere – in all likelihood including your local electrical wholesaler.

“The spending revenge on the back of COVID is a major contributory factor to the high prices we are experiencing today,” says Sok Lay, a Financial Advisor at Master Your Money Now.

Derek elaborates: “With Covid, producing products was more difficult because of the shutdowns, so fewer products were produced, which meant they could fetch a higher price. And then recently, demand for products went up because of pent-up demand coming out of isolation and because of an increased money supply that was handed to the people from the government.”

Additionally, the war in Ukraine has disrupted energy supply chains, meaning global energy prices have also increased significantly.

Still with us? Good.

Why do interest rates rise?

Across the world, governments measure inflation and like to keep a cap on it. Essentially, when consumer prices go up, the ‘real’ value of money goes down, as does the value of savings and the value of debts.

Low inflation contributes to an economy’s stability and is more attractive from an investment perspective – higher inflation means our purchasing power is reduced, investments are worth less and workers need more money, which in turn further increases the prices businesses need to charge.

In Australia, at the last count (May 2023), year-on-year inflation was 5.6 per cent, a little down on the previous months, but still way above the Reserve Bank’s 2-3 per cent annual inflation target.

Of course, as we’re all very well aware, the RBA’s answer to this problem is to jack up the interest rates, which ultimately means that people with mortgages (serious amounts of debt) are significantly worse off, while those with huge savings get richer and richer.

“The government can combat inflation mainly by increasing interest rates,” explains Derek.

“It’s the most effective way to impact inflation immediately before it becomes a bigger issue. Increased interest rates slow down demand by slowing down borrowing – people/businesses might love borrowing at 2 per cent interest, but they’re less likely to borrow at 6 per cent interest.

“With decreased demand, prices should stop rising at such a high rate. This brings inflation back to where it should be, at around 2 per cent.

Sok says that increasing the interest rates is like turning down the heat.

“Think about burning a candle,” she says.

“If we light the candle normally, it’ll burn at the normal speed [2-3 per cent inflation].

“However, as inflation increases, it is the equivalent of more and more people lighting lighters and holding them next to the candle – all of a sudden, the candle is melting faster than is sustainable.”

How long will interest rates go up for?

So, what’s the outlook for the next few months? The RBA has said it’s a ‘whatever it takes’ approach to reducing annual inflation back to 2-3 per cent, so until it gets there, we could see more interest rate rises – although, at the time of writing, only ANZ is predicting another interest rate rise in 2023.

Derek warns, however, that prices won’t go back to what they were a year ago.

“The intent isn’t to get prices back down to where they were a year ago. The goal is to slow the increase, so don’t expect the cost of groceries to go down. They’re likely here to stay.”

So there you have it – the sooner we all stop spending, the sooner the interest rates will stop rising, and hopefully begin falling.