Only those still living in the 1970s would want the central bank to prematurely choke off wages growth when there is no cause to.
At its first meeting of the year on Tuesday, the Reserve Bank Board should ignore demands for an increase in the cash rate in 2022. Instead, it must hold firm to its position that monetary policy settings should support full employment and consequential wage rises and not squash them through a premature monetary tightening.
Financial markets, backed by conservative economic commentators, are betting on the Reserve Bank being forced to abandon its earlier intention to hold the cash rate at 0.1 percentage point until 2024 https://www.rba.gov.au/speeches/2021/sp-gov-2021-11-02.html and bring that date dramatically forward to 2022.
The Reserve Bank has been on the right track for around two years, after being on the wrong one for many more. From 2015 to 2020, the Reserve Bank’s monetary policy decisions led to its preferred measure of inflation sitting beneath its 2-3 per cent target range while full employment had not been achieved either – as evidenced by weak wages growth.
Until early 2020, the Reserve Bank kept Australia’s interest rates higher than those in other advanced economies. By doing so, the Bank influenced the exchange rate. Australia’s tighter monetary policy attracted foreign money into the country, forcing the exchange rate up and causing job losses as our exporting and import-competing industries became less competitive.
As argued by Ross Garnaut in his book, Reset, the Reserve Bank, by being out of step with the central banks of the rest of the developed world, contributed to higher unemployment and weaker wages growth.
The Reserve Bank appears more recently to have acknowledged this, Deputy Governor Guy Debelle saying last May that by coming late to quantitative easing, the Reserve Bank’s policy “was contributing to a higher exchange rate, which was restraining the recovery in the Australian economy” https://www.rba.gov.au/speeches/2021/pdf/sp-dg-2021-05-06.pdf
Since 2020, a combination of quantitative easing and a near-zero cash rate has stimulated the Australian economy during its biggest economic shock since the Great Depression, playing an important part in lowering the unemployment rate to 4.2 per cent.
Conservative economists, who had no problem with the Reserve Bank for years undershooting the inflation target and failing to achieve full employment, now demand that the mere possibility of wages growth be met with quick and decisive tightening.
There has been no wages breakout to set in train a dreaded wage-price spiral of the type following the two oil price shocks of the 1970s.
In Australia, the inflation dragon remains in its cave, though it breathed a lick of fire in the December quarter https://www.afr.com/policy/economy/inflation-to-force-rba-interest-rate-pivot-20220125-p59r1x
The lift in Australia’s inflation rate has largely been caused by supply shortages rather than by excess demand.
Early in the pandemic, empty supermarket shelves were caused by consumers hoarding toilet paper and other household essentials. Now they are being caused mainly by supermarket workers and those in the supply chain being infected with the virus and quarantining at home.
Responding to temporary supply shortages by suppressing consumer demand through tighter monetary policy makes as much sense as allowing children to drive forklifts.
While US inflation has shot up to an annual rate of 7 per cent https://www.afr.com/policy/economy/us-inflation-surge-sets-stage-for-march-rate-increase-20220113-p59nua there is no reason to believe that Australia’s inflation rate will follow.
The US inflation rate and tightness in its labour market have led to increases in nominal wages https://www.afr.com/policy/economy/rate-rise-bets-intensify-as-us-hits-full-employment-20220109-p59mtv
Not so in Australia, where the most recent annual wage price index has only just poked above 2 per cent.
It is true that higher international prices for oil, meat, timber and many other commodities flow through to Australian prices – more so with a falling Australian dollar in response to higher US interest rates.
But experience since the late-1990s shows that without accelerating wage increases from full employment, these are one-off effects. The RBA can wisely allow them to pass through the economy, as it has done in the past.
If Australia were truly at or near full employment, businesses would be obliged to offer wage increases to retain their existing workers and attract new ones.
That this is not happening on a widespread basis is possibly due to employers being worried about another coronavirus variant sending them backwards, leaving them stuck with a bigger wage bill and falling sales.
The Reserve Bank lifting the cash rate in 2022 would only increase employer anxieties, choke off any increases in consumer and investor spending and ensure Australia moves away from full employment not closer to it.
Full employment and real wage increases should not be seen as economic problems to be solved but as desirable policy goals. They can be achieved through an accommodative monetary policy and sustainably through productivity growth that is fairly shared.
Much of the pre-Omicron economic recovery was a consequence of accommodative fiscal and monetary policies.
The Reserve Bank should ignore demands to choke off a possible economic recovery through tighter monetary policy from those who insist on living in the seventies and watching economic horror movies about inflation dragons as their guide to economic policy in the 2020s.
Craig Emerson is managing director of Emerson Economics. He is a visiting fellow at the ANU, Director of the APEC Study Centre at RMIT and adjunct professor at Victoria University’s College of Business.