The Reserve Bank seems so determined to continue hiking interest rates that it is relying on outdated productivity growth estimates to justify its decisions. No policy lever can magically lift productivity growth in the coming months, so the outlook for interest rates and the economy is bleak.
Monetary policy is a short-term macroeconomic stabilisation tool. Productivity growth requires long-term microeconomic reforms that increase competition, educational attainment and the uptake of new technologies embodied in investments involving long lead times.
Australia has had a productivity problem since the turn of the century. The Productivity Commission has pointed out that Australia’s productivity performance in the decade ending in 2019-20 was the worst in 60 years.
Our labour productivity performance has worsened since then, with GDP per hour worked falling by an average of 0.8 per cent over the last five quarters.
In Governor Lowe’s speech delivered the day the national accounts were released, he expressed alarm at the increase in unit labour costs over calendar year 2022, which, he pointed out, was one of the largest annual increases during the three-decade inflation targeting period. The national accounts confirmed that unit labour costs continued to rise strongly in the March quarter.
At the same time, the board knew that the economy is slowing alarmingly. It knew that, in April, retail sales were sharply down in real terms and that building approvals had collapsed to their lowest levels in more than a decade.
The national accounts released the day after the board meeting also revealed that household spending in the March quarter rose by just 0.2 per cent, the slowest quarterly growth since the Delta lockdowns.
As for all the savings buffers built up during the pandemic that the Reserve Bank had been indicating were being used to sustain strong consumer spending, the national accounts revealed the household saving ratio declined to its lowest level since June 2008.
The Reserve Bank also knew that more than 40 per cent of the value of fixed-rate mortgages taken out when interest rates were at record lows are yet to roll off onto much higher variable rates.
That’s a lot more contraction already locked into the system but not yet felt.
Against all these indicators pointing to a sharply slowing economy, the Reserve Bank board decided it had the evidence justifying a further rate rise.
In his Wednesday speech, Governor Lowe said the best way to achieve a moderation in growth in unit labour costs was through stronger productivity growth, and that “the board therefore will continue to pay close attention to trends in productivity growth.”
The next productivity numbers will be released with the national accounts on 6 September, the day after that month’s Reserve Bank board meeting.
So when the board meets on the first Tuesday of the next three months, it will know only the productivity numbers that were released last Wednesday – which by then will be three to six months old.
The same goes for unit labour cost numbers.
Since the board is now relying explicitly on productivity growth numbers in deciding at its monthly meetings whether to increase the cash rate, and since those productivity numbers are weak, old and getting older, the Reserve Bank appears locked into further interest rate rises.
Productivity growth conventionally is reported in cycles spanning several years to remove much of the statistical noise in annual numbers and the even greater noise in quarterly numbers.
Governments should pull every lever available to them to lift productivity growth. That requires a new era of microeconomic reform, adopting many of the policies recommended by the Productivity Commission in its recent major review. But if all those policies were implemented tomorrow it would take years for the resulting productivity gains to be realised.
If, however, the Reserve Bank’s main concern is the pace of wage rises, it will look at unit labour costs, which have been climbing. But since this, too, is quarterly data, it creates the same problems as the quarterly productivity data for a central bank making interest-rate decisions on a monthly basis.
Following the opening of Australia’s borders, immigration is surging, as sought by business and promised by the Albanese government at the Jobs and Skills Summit.
This is a sensible response to post-pandemic labour shortages. The present combination of a sharply slowing economy and rapidly increasing immigration will ease wage pressures.
Between now and the release of the June quarter national accounts the Reserve Bank board will meet three times. It appears to be set on a path of further cash rate rises at its coming monthly meetings.
Choking the demand for labour through further interest-rate hikes will drive businesses to the wall and workers onto the dole queues for no good reason.
The Reserve Bank board’s reliance on badly outdated quarterly data to justify further monthly cash-rate increases spells disaster for the Australian economy.
Craig Emerson is the CEO of Emerson Economics. He is director of the APEC Study Centre at RMIT University, visiting fellow at the ANU and adjunct professor at Victoria University’s College of Business. He was chair of the Productivity Committee of Cabinet in the Gillard government.