There are no wage or currency pressures that would justify the RBA following the Fed into aggressive rate rises.
Australia need not follow the US into recession. In important respects, Australia’s economic circumstances are different from those of the US. They warrant a less-aggressive approach to monetary policy than that being pursued by the US Federal Reserve.
The Federal Reserve is now conceding the US might be heading into recession. If so, America will have plenty of company without us – Britain is already there, while the Eurozone is heading that way and Chinese growth is the slowest since the beginning of the reform era 44 years ago. The World Bank is now warning of a global recession.
On 16 September, Reserve Bank Governor, Philip Lowe, told a House of Representatives economics committee meeting that the board would consider a further increase in the cash rate at its October meeting, while also indicating that the pace of cash rate increases might slow.
But since then, the Federal Reserve has increased its benchmark rate by a further 0.75 percentage points, its chairman, Jerome Powell, warning that the prospects of avoiding a US recession are diminishing. The median outlook for the Fed funds rate for end-2023 among its open market committee members is 4.5 per cent.
Those arguing for a further 0.5 percentage point increase in the Reserve Bank’s cash rate at its October board meeting suggest the fall in the Australian dollar against the US dollar to below US66¢ will add to existing inflationary pressures. Yet, on a trade-weighted basis the Australian dollar has appreciated by more than 2 per cent in 2022. The US dollar attracts all the attention, but the US is a relatively unimportant trading partner for Australia.
While the US has a tight labour market, exerting such strong upward pressure on nominal wages that it might be a cause of high price inflation, the anticipated surge in Australian nominal wages is not yet in the ABS data and most analysts suggest that wages are holding back inflation not forcing it up.
There is no evidence that a wage-price spiral will eventuate in Australia. Two of the Reserve Bank’s own economists conclude that https://www.rba.gov.au/publications/bulletin/2022/sep/pdf/wage-price-dynamics-in-a-high-inflation-environment-the-international-evidence.pdf the overall risk of a wage-price spiral emerging in most advanced countries “is probably quite low, and certainly lower than in the 1970s.” They cite as mitigating any wage-price spiral greatly weakened bargaining power of trade unions and the lower prevalence of wage indexation.
It is true that unemployment and job vacancies in Australia are at historically low levels. But the Albanese government announced at the Jobs and Skills Summit early this month that it would increase the permanent migration intake this year from 160,000 to a record 195,000 places and speed up visa processing for foreign workers. And the government will improve work incentives for working mothers and age pensioners, further bolstering the workforce.
Already the Reserve Bank has lifted the cash rate at its fastest pace since the mid-1990s. Markets are now expecting an increase of 0.50 percentage points on the back of the Federal Reserve’s decision to lift its rate by 0.75 percentage points.
Markets are now also pricing in a peak Reserve Bank cash rate of more than 4 per cent, which implies mortgage rates of around 7 per cent. Australia’s households are the second-most highly indebted in the world. A Reserve Bank cash rate of 4 per cent would plunge the Australian economy into a deep recession.
Most US mortgage holders are on 30-year fixed rates, making their spending far less sensitive to mortgage rate rises than their Australian counterparts.
At the House economics committee meeting, Governor Lowe described high inflation as a “scourge”. But so are recessions.
Yet the Albanese government is expected to have no interest in the Reserve Bank’s monetary policy settings.
The Reserve Bank can retain its independence without the prime minister being reprimanded for suggesting that, while acknowledging the Reserve Bank’s independence, it needs to be careful not to “overreach” on monetary tightening https://www.afr.com/policy/economy/albanese-right-to-question-high-priests-of-central-banking-20220731-p5b62m
As former Reserve Bank research department member, Peter Tulip, observed: “Rising interest rates will be hurting a lot of Australians, and it would seem insensitive not to say anything about it,” describing the prime minister’s comments as “bland and inoffensive.” https://www.afr.com/policy/economy/taylor-lashes-albanese-over-rba-overreach-comment-20220721-p5b3hp
Governor Lowe was right to explain to the House economics committee that high inflation damages the economy. But recessions are damaging too, destroying jobs and smashing small businesses.
The Governor was also right to warn that the path the Reserve Bank is seeking to tread with its monetary policy settings is narrow and clouded in uncertainty. But if the Reserve Bank follows the path of hard tightening being trodden by the Federal Reserve, Australia will join the US in recession.
Craig Emerson is managing director of Emerson Economics. He is director of the APEC Study Centre at RMIT, a visiting fellow at the ANU, adjunct professor at Victoria University’s College of Business and chair of the McKell Institute.