Rising costs to bite diners

"Rising costs set to bite diners". Forget the $40 course at restaurants, gentle readers, rising costs of food are causing real hardship across a lot of Australia. Coming on top of rising interest rates and rising petrol prices, many Australians are feeling the pinch.

Can we sort out cause and effect here?

We have written many times before about the effect of too much money chasing too few goods. And also that inflation is a global phenomenon.

Of course in the real world "goods" are not a single item. Also there are assets as well as goods to spend money on. This point has been especially important in recent years. Each country is (imperfectly) connected in many markets to other economies. The net result is that the effect of too much money can be difficult to sort out.

The prices of "goods" or "goods and services" (measured by an index such as the consumer price index) has, until recently, been held down by the rapid development of China, India and other "emerging nations".

There has been too much money - essentially led by cash rates at a too low 1 per cent in the US economy - available too easily in most nations, including Australia. However, the China-India-emerging nation developments have held down the prices of goods and services so the excess money has mainly forced up asset prices.

Asset prices are not just influenced by the money supply, of course. Asset prices are also influenced by the supply of, and demand for, assets; and just recently asset demand has been depressed by a battered investor sentiment.

Partly this is a consequence of tighter monetary policy, but readers will immediately realise that sharp rises in asset prices can "overshoot": indeed, economists see "overshooting" as an inevitable characteristic of asset markets. Once asset prices have "overshot" the stage is set for reversal. We are experiencing such a reversal now, with greatly increased volatility in financial markets along with net falls in asset prices.

If the price of assets plunge because sentiment about asset prices is depressed, to the extent there is excess money still in the system, goods and services inflation will rise.

This seems to be what is happening now. Goods and services inflation is up in almost every nation, as excess money now raises goods and services price inflation rather than asset prices as it was while investor sentiment was strong.

As noted, "goods and services" are not a single "thing" with a single price. They are many, many things. The price of each thing is influenced by particular factors, for example, drought or flood influences the price of bananas, general food shortages increase the price of food, geopolitical tensions influence the price of oil, attempts to control the economy influences the price of money, and so on.

Given all the myriad of factors, including investor sentiment, that influence the supplies of, and demands for, all available assets, goods and services in all nations, it is not surprising that the overall effects of changes in monetary policies are hard to sort out.