The central bank should pause and look at the lagging data. But it is unlikely to find evidence of an inflation problem from another era.
At the Reserve Bank Board’s December meeting it should pause on cash rate rises. Following the second-most aggressive tightening in its history, the Reserve Bank should take the time to assess the lagged effects of its restrictive policy and reassess in February.
In his Tuesday evening speech at the Annual CEDA Dinner, Reserve Bank Governor Phil Lowe has an opportunity to make the case for a pause in cash rate increases. At its November meeting, the Reserve Bank Board began to do just that. But the Board covered the field by entertaining further increases of 25 and 50 basis points, adding that it expects to increase interest rates further over the coming period.
Nothing in the most recent wages and jobs data indicates a debilitating 1970s-style wage-price spiral. Yet financial markets are pricing in a peak cash rate of about 3.75 per cent by mid-2023, sharply up on the present 2.85 per cent following seven successive monthly hikes.
If financial markets are correct in their predictions of further cash rate rises the Reserve Bank would have taken the Australian economy to the edge of recession.
Already the Reserve Bank is forecasting GDP growth of just 1½ per cent in each of 2023 and 2024. At that average annual growth rate, two or more successive quarterly negative growth rates are in prospect – which, if happened, would constitute a technical recession.
A further cash rate increase in December would lift mortgage payments to their highest on record. Despite many households having sufficient funds in offset accounts to enable them to meet the higher mortgage payments, they inevitably will cut back on spending elsewhere, cooling the economy.
The latest wages data confirms real wages are continuing to go backwards.
So where is the evidence of the dreaded wage-price spiral?
When asked what he’d like for his birthday, a comedian in the 1980s replied: “Nuclear war so as to remove the threat of it.” Sometimes it feels like doctrinaire monetarists are hoping for evidence of a wage-price spiral so they can remove the threat of it by slamming the economy into recession.
While the Reserve Bank Board has been on the lookout for a wage-price spiral it hasn’t yet found one. Yet the prospect of a wage-price spiral is driving the Board’s contemplation in its November statement of possible further monthly cash rate increases of up to 50 basis points.
But what if the economic diagnosis is wrong?
Like the early-1980s threat of nuclear war, the early-1980s wage-price spiral was a product of conditions that prevailed at the time. They included two massive oil-price shocks, centralised wage fixing and union density of around 50 per cent compared with less than 15 per cent today.
Having failed to anticipate the post-pandemic inflationary surge, central banks around the world are now supremely confident that they are correct in their savage monetary tightening to prevent a wage-price spiral.
Do global central bankers ever engage in self-reflection?
What if, just like their immediate post-pandemic policy misses, these central bankers are misdiagnosing the current inflationary bout?
Rather than experiencing a 1980s wage-price spiral, Gerwin Bell has suggested the world might be undergoing an inflationary episode more akin to that of the immediate post-war era.
World War II had unquestionably disrupted supply chains and created labour shortages as workers became soldiers and fought in armies. And to put it mildly, fiscal and monetary policy were in full-bore expansionary mode.
At war’s end, inflation surged, but the authorities did not respond by tightening fiscal and monetary policy to prevent the emergence of a wage-price spiral.
Rather, supply chains were repaired, soldiers came home to work and inflation soon abated without the need for sharp monetary tightening.
The preponderance of central bankers around the world lived through the 1970s and 1980s but none through the 1940s. They relied on economics textbooks covering the experiences of the 1970s and 1980s and far less on economic history books.
It is not surprising, therefore, that groupthink afflicts the central banking class of the 2020s.
Here in Australia, the Reserve Bank at least is open to entertaining the possibility that a wage-price spiral might not eventuate.
Nothing would be lost by the Reserve Bank Board pausing at its December meeting and having a fresh look at the economic data to inform its cash-rate decision at its February meeting.
There’s a desirable humility in a central bank acknowledging that its staff and its economic models cannot predict the future with confidence. Lately, the tone of Reserve Bank statements reflects such humility. Hopefully, Governor Lowe’s speech at the CEDA dinner will continue that refreshing approach.
Craig Emerson is managing director of Emerson Economics. He is director of the APEC Study Centre at RMIT University, a visiting fellow at the ANU and adjunct professor at Victoria University’s College of Business.