Could cutting government spending bring down inflation?

A common question in the comments section of our Instagram posts is: “Why doesn’t the Government just cut back on its spending to stop inflation?”

It’s a fair question, and one that gets to the heart of an ongoing economic debate.

We’ve asked Diana Mousina, the deputy chief economist at AMP, for the key reasons for and against the Government cutting its spending.

Let’s unpack what is going on.

Inflation is the general increase in prices in an economy.

Last week, the Australian Bureau of Statistics reported that the inflation rate was 4.3%, increasing for the second consecutive month.

Yesterday, the Reserve Bank of Australia (RBA) raised the cash rate to 4.85%, the highest it’s been in 18 years.

The RBA lifts rates to cool spending and bring inflation back to its 2-3% target.

One way inflation can increase is when too much spending occurs relative to the goods and services available.

Imagine a hamburger shop that is getting more customers than it can serve.

A natural response from the shop is to increase its prices.

Sure, it might lose some customers but it’s already at capacity, so it doesn’t mind.

Now imagine this playing out in millions of shops around the country, and you’ve got an economy with rising inflation.

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AMP Deputy Chief Economist Diana Mousina said there is evidence to support calls for the Government to cut spending.

She said total government spending across federal and state governments is at a record high, at around 28% of gross domestic product (GDP).

“Government spending is adding to demand, so we need to see a reduction in spending across the board, and the Government is part of that,” she said.

However, Mousina noted that cutting government spending is easier said than done.

“It means a cutback in services.

So does that mean a cutback in teachers, in police, in staff at hospitals?

Does it mean a cut in public sector employment, which is ultimately also an impact on households?” she said.

She said cuts could also affect welfare payments for unemployed people, support for single parents and Commonwealth Rent Assistance.

The Government will release the Mid-Year Economic and Fiscal Outlook (MYEFO), which is an update to the annual budget, in December.

Finance Minister Katy Gallagher and Treasurer Jim Chalmers both recently said the Government is working on savings in MYEFO.

However, neither committed to more savings than new spending while cabinet is still deciding what to cut and what to fund.