Having lifted the cash rate 11 times in the last 12 months, the RBA risks triggering a recession if it continues on its tightening path. The sharp lift in inflation as the economy roared back to life following the COVID-19 pandemic warranted a series of cash-rate increases. But the main source of inflation at that time was not excess demand but supply shortages, which could be expected to ease of their own accord, without needing to squeeze money out of the economy to drive down demand.

The Reserve Bank in multiple public statements in the last year has warned of a wage-price spiral (which it later renamed a price-wage spiral). It feared a repeat of the late-1970s and the early-1990s when wages followed prices up in an inflationary cycle.

But times have changed: the wage-fixing system has shifted from a centralised to a largely decentralised system and in the immediate pre-pandemic years there were around 2 million temporary visa holders supplying the Australian labour market at any given time. The big catch-up in both permanent and temporary migration following the ending of the COVID-19 restrictions is boosting the labour supply once more, impinging on wage rises.

There is no evidence of a wage-price spiral. Yet the Reserve Bank has estimated that the unemployment rate needed to prevent such a spiral is 4.5 per cent. This is much higher than the present rate of 3.7 per cent. If the Reserve Bank were to engineer an increase in the unemployment rate to 4.5 per cent through further interest-rate increases, it would plunge Australia into recession and around 140,000 more Australians into joblessness.

Some commentators point to the much higher official interest rates in the US when arguing for further rate hikes in Australia. But the transmission system for interest-rate rises in the US is different from Australia’s. In the US, mortgage rates are typically fixed for 30 years. In Australia, fixed mortgage rates last for only 2-3 years, after which mortgage holders are transferred onto the prevailing variable rate. That’s what’s happening now, making each rise in the Reserve Bank’s cash rate much more potent and immediate than the same increase in US official interest rates.

Instead of preventing a mythical wage-price spiral, the Reserve Bank should press pause on interest rates and keep Australia out of recession.

Craig Emerson
Managing Director
Emerson Economics