This is a tale of high priests and Trappist Monks. It is written that the high priests of the Reserve Bank at Martin Place shall be spared interference from elected philistines. But should we interpret the scriptures as obliging the prime minister to behave like a Trappist Monk, forbidden the smallest utterance about monetary policy?
The federal opposition and many scribes are tut-tutting prime minister Albanese’s statement – following his reconfirmation of the Reserve Bank’s independence – that “they need to be careful that they don’t overreach as well.”
No mortal is infallible. Not priests. Not monks. Not even the Pope. Nor is it a mortal sin to comment on their behaviour.
Albanese followed up by pointing out that the Reserve Bank had committed in 2020 to keeping the cash rate at just 0.1 per cent until 2024 – but began increasing rates in 2022. That commitment was an error Governor Lowe has described as “embarrassing”.
This was not the Reserve Bank’s original sin.
From 2015 until the pestilence of COVID-19 arrived, the Reserve Bank’s interest rate decisions led to an inflation rate below its 2-3 per cent target. At the same time, as evidenced by weak wages growth, full employment wasn’t achieved either.
In 2020, Governor Lowe announced the Reserve Bank’s decision making would put greater weight on written inflation instead of on its prophecies of inflation. Targeting its own false prophecies of inflation led the Reserve Bank to keep interest rates too high for too long.
Then Deputy Governor, Guy Debelle, acknowledged this in 2021, saying the higher Australian government long-term bond rate “was contributing to a higher exchange rate, which was restraining the recovery in the Australian economy.”
In 2020, the Reserve Bank reluctantly joined the international quantitative easing club, a sort of wedding feast at Cana. By purchasing bonds in the secondary market, it sought to keep the three-year bond yield at 0.1 per cent.
Faced with a pandemic of unknowable severity and duration, the Reserve Bank’s extremely expansionary monetary policy was justified. It helped save Australia from a prolonged and brutal recession.
But now that inflation is on the rise, the Reserve Bank has not only necessarily broken its 0.1 per cent commitment, it has also hiked the cash rate by 1.25 percentage points in just nine weeks – the fastest escalation in almost three decades.
Governor Lowe is signalling that the Reserve Bank could double the cash rate in coming months suggesting the neutral rate is “at least 2.5 per cent.” A rate hike on Tuesday is inevitable, probably taking the cash rate to 1.85 per cent, well on the way to 2.5 per cent.
This sharp tightening of monetary policy is being justified by rapidly rising inflation and fears of a 1970s-style wage-price explosion.
But as Christopher Joye reports, Commonwealth Bank (CBA) data, based not on prophecies but on actual wages paid into around 300,000 bank accounts, suggests wages are rising by around 2.5 per cent per annum – hardly an explosion.
Further, CBA economists explain that when account is taken of both interest costs and principal repayments, lifting the Reserve Bank’s cash rate to 2.5 per cent would put household debt servicing costs back to around 2008 levels when the cash rate was 7.25 per cent.
Forward indicators of the Australian economy are pointing downwards The OECD composite leading indicator for Australia is suggesting a sharper downturn for Australia than for the US, Britain and the OECD as a whole.
The CBA argues that the Reserve Bank is not facing a wage-price spiral as is occurring in some other countries. It had previously thought the Reserve Bank would gradually raise the cash rate to 1.6 per cent by February 2023, which it considered the right policy path.
The International Monetary Fund has downgraded its growth forecasts for Australia, the region and the world, while the US has recorded its second consecutive negative quarter of economic growth – contrary to the expectations of the Federal Reserve chairman, Jerome Powell.
Australia’s inflation rate might turn negative next year as petrol prices fall and supply-chain pressures ease.
If the Reserve Bank’s strategy is to sermonise the inflation rate down, then that might work without doing lot of economic damage. But if it is intent on slaying the weary wage-price inflation dragon of the 1970s with big interest rate hikes, it could inflict terrible damage on consumers, workers and businesses.
Prime minister Albanese has a legitimate interest in the conduct of monetary policy, just as he does in fiscal policy. He, treasurer Jim Chalmers and finance minister Katy Gallagher have a monumental task in reducing budget deficits and beginning to pay off almost $1 trillion of inherited debt, as Chalmers explained last week.
Albanese is within his rights to shun those who demand he take a vow of silence on monetary policy. It’s unlikely he will engage in a running commentary, but it is reasonable to suggest that the Reserve Bank be careful about overreaching and causing unnecessary hardship for mortal Australians.
Craig Emerson is managing director of Emerson Economics. He is director of the APEC Study Centre at RMIT University, visiting fellow at the ANU, adjunct professor at Victoria University’s College of Business and chair of the McKell Institute.