It would make my life easier if Australia’s inflation problem had a simple cause done by a single villain. Alas, that is not the case.

Prices are rising for several reasons, and there’s plenty of blame to be shared around.

The government deserves their share of the blame

As many others have noted, the government is spending more money than they have (despite bringing in record-high taxes) and running unnecessary budget deficits.

This has three consequences, depending on who is lending the money:

1. If the money is lent by foreigners, the consequence is a stronger Australian dollar, which leads to more imports and fewer exports, and therefore less Australian business.
2. If the money is lent by Australian investors, the consequence is less money available for other investments, and therefore less money going into Australian business. If that money instead comes from foreign lenders, then see problem #1.
3. If the money is lent by Australian banks, the consequence is more money circulating in the economy, which leads to higher inflation.

There is some connection between government over-spending and the inflation rate, but it’s not as automatic as some people claim.

Though this doesn’t let the government off the hook. Indeed, while the current focus is on how government spending is pushing up inflation, arguably the bigger problem with budget deficits is that they directly hurt Australian businesses … but that’s a story for another day.

Blaming the war

Obviously, the government doesn’t want to accept any blame for high inflation, so they’re pointing the finger at the Iran war. The problem with this story is that Australia’s inflation was running above the 2-3 per cent target long before the Iran war started. Nonetheless, there is some truth to the war argument.

At its core, inflation is caused by too much money chasing not enough stuff. Or to put that in Keynesian terms so that the media can understand, when Aggregate Demand is growing faster than Aggregate Supply.

The government is contributing to the problem when they add more money into the economy, but the war is also contributing to the problem because it is creating a negative supply shock. This means we are facing the double whammy of both more money and less stuff at the same time. The size of this supply shock will depend on how long the Iran conflict continues, and when fuel supplies will start flowing normally again.

The real culprit

While the government and the war both deserve their share of the blame, the other villain often flies under the radar since the politicians don’t have an incentive to blame them. It is literally the job of the Reserve Bank of Australia (RBA) to keep inflation under 3 per cent per year, and they have failed.

During the Covid drama, the RBA cut interest rates too low for too long, which caused a massive increase in the amount of money circulating in the economy, leading to the inevitable inflation. The RBA was then too timid in raising interest rates post-Covid, so inflation was never brought fully under control. And then the RBA inexplicably started cutting interest rates in 2025, which caused inflation to kick up again.

It is true that government spending and the Iran war have put upward pressure on inflation, but it’s the job of the RBA to adjust for these sorts of impacts.

Final thoughts

This article has half-defended the government by admitting that inflation was partly caused by the war and is ultimately the responsibility of the RBA, but this isn’t a good story for the government.

Consider the options:

• If the RBA fails at their job, then government over-spending contributes to relatively high inflation.
• If the RBA does their job properly then inflation stays under control, but then government over-spending contributes to relatively high interest rates.
• In both cases, government over-spending crowds out private businesses, holding back the Australian economy and leaving the country poorer.

In every scenario, Australia would be better off if the government was able to get their spending under control and balance their budget, and the RBA stuck to their core job of keeping inflation low. The big question is whether our political leaders will learn this lesson before things get worse?

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