Australia’s economy is operating at zero growth, yet economists are warning it is running too hot, forecasting it will fuel inflation in the coming quarter. That seems implausible, but even if those economists are right, it doesn’t mean the Reserve Bank should be jacking up interest rates.
Inflation is at 3.6 per cent, sharply down on its peak of 7.8 per cent less than 18 months ago. The present inflation rate is around where, in the middle of last year, the Reserve Bank forecast it to be by now, and only a little above the target range of 2-3 per cent.
Talk of a need to increase the cash rate is misguided – especially so when the main culprits behind the 3.6 per cent inflation rate are identified.
Alcoholic drink prices spiked (so to speak) but was that due to an excise increase rather than excess demand for beer, wine and spirits?
Dwelling rents have continued to rise owing to a housing shortage. How would an increase in the cash rate reduce them? By throwing renters onto the streets to reduce the demand for rental accommodation?
Insurance premiums have risen sharply too. Is the right macroeconomic policy prescription to increase interest rates to such heights that people cannot afford to take out insurance?
Private school fees were hiked at the beginning of the school year. Would better-off parents truly switch their children to state schools if the Reserve Bank increased the cash rate?
If this analysis is right – that the main culprits behind the inflation rate are insensitive to increases in the Reserve Bank’s cash rate – then the Bank would need to go much harder against discretionary spending to bring down the overall inflation rate.
That, dear friends, is a nasty recession.
New deputy governor, Andrew Hauser, recently told the Financial Review that he and his colleagues at the Reserve Bank take seriously their dual obligation of getting inflation into the 2-3 per cent band while preserving employment gains from not going too hard. This, together with similar statements from Governor Michele Bullock, is very encouraging.
The Reserve Bank has readily acknowledged that the lags from monetary tightening are usually long and variable.
Who’s to say that the economic contractionary effects from the existing monetary tightening have already fully played out?
While Deputy Governor Hauser has rightly pointed to the social costs of high inflation the Reserve Bank does not appear to be in a desperate hurry to drive it into the 2-3 per cent band at the cost of a fully blown recession. Moreover, the Reserve Bank has readily acknowledged that there is little evidence of a price-wage spiral.
Recessions, too, inflict heavy social costs on the vulnerable.
Australia’s experience with recessions is not one of slipping into them and just as easily sliding out again. They are dreadful in human terms, scarring many of the workers and small businesses who lose their livelihoods.
Older workers might never regain employment and lower-skilled younger workers can be out of work for years. Small business owners who have become insolvent might lose their family homes, which they often are required to put up as security against their business borrowings.
We live in bizarre times when an economy that is not growing at all is considered to be growing too fast, with some leading economists forecasting the Reserve Bank will need to increase the cash rate 2-3 times this year. Others assert that, with the Reserve Bank refusing to adopt their tightening prescription, it must be a lapdog of the Albanese government.
A third explanation is that the Reserve Bank accepts its dual role readily and has not seen circumstances that warrant it increasing the cash rate.
Recessions should not be considered merely as an antidote to an inflation rate sitting just outside the mandated 2-3 per cent band. The economic and social cost of a 3.6 per cent inflation rate for a little longer than desirable is small compared with that of a confidence-sapping, livelihood destroying recession.
Those who consider the Reserve Bank could engineer a mild recession that’s worth having to fine tune the inflation rate down from 3.6 per cent to the 2.5 per cent midpoint of the mandated range might contemplate Australia’s history: unemployment exceeded 10 per cent in the recessions of the early 1980s and the early 1990s.
This is not a prediction but a warning – don’t play with recessions; they are like a pack of wild dogs mercilessly mauling innocents who might never recover.
Craig Emerson is managing director of Emerson Economics. He is director of the APEC Study Centre at RMIT University and adjunct professor at Victoria University’s College of Business.