Following last week’s release of the inflation numbers for the March quarter, most economists are forecasting that the Reserve Bank won’t start cutting interest rates before the end of 2024, with some urging further cash-rate increases. If this collective view were to sway the RBA, thousands of Australian jobs and small businesses would be destroyed for no good reason.
Among the main contributors to the March quarter inflation result were rents and insurance premiums. Using tight monetary policy to force down rents and insurance premiums must be the bluntest and dumbest imaginable policy instrument. Higher interest rates would deter new dwelling construction and force more people to abandon insurance of homes, contents and vehicles.
Another source of inflation in the March quarter was private school fees, which typically are reset at the beginning of the school year. Those increases will fall out of the June quarter’s CPI. It is fanciful to think that persistently high interest rates would push school fees lower.
Petrol prices have increased in the last few weeks, which will add to the June quarter CPI, but the Reserve Bank’s monetary policy settings won’t reduce the world price of oil that has increased on fears of a wider war in the Middle East.
Nor is there any evidence of a price-wage spiral of the sort witnessed in the early 1980s when Australia’s wage-fixing system was highly centralised. In fact, the Reserve Bank Board’s minutes from its October meeting concluded that “there were few signs of the risk of a price-wage spiral materialising.”
Missing from most of the headlines and stories commenting on the March quarter inflation figures was the fact that annual inflation had dropped to a 2½ year low 3.6 per cent, down from 4.1 per cent in the year ended in the December quarter and 7.8 per cent in late-2022..
Despite the 3.6 per cent inflation rate sitting not very much above the top of the Reserve Bank’s 2-3 per cent target range, it has been interpreted by most economists as a disaster.
In fact, the 3.6 per cent result was slightly below the Reserve Bank’s indicative forecast of 3.7 per cent in its February statement on monetary policy.
Yet economic forecaster Warren Hogan is urging a lift in the cash rate three times this year to 5.1 per cent and Christopher Joye has described the result as “a big upside surprise”, calling it as an “inflation crisis” and arguing that the RBA’s macro models imply the cash rate should be 5 per cent or even higher.
If that’s the case, let’s hope the RBA isn’t firing up its models ahead of its meeting next month.
A smarter approach is inferred in the minutes of the Reserve Bank Board’s March meeting. Board members noted that the monthly CPI indicator excluding volatile items was around 4 per cent in year-ended terms in January and had declined below 3 per cent on a three-month-ended annualised basis.
The Board warned that a rebound was anticipated in coming quarters as recent declines in fuel prices and the pace of decline of some household goods prices were not expected to persist, and electricity rebates were legislated to expire.
Treasurer Jim Chalmers has signalled that on top of the personal tax cuts to come into effect on 1 July, some limited cost-of-living relief will be included in the May budget, while cautioning that: “We see it as a way of taking the pressure off inflation, not adding to it.”
By explicitly pointing to the legislated expiry of electricity rebates as a source of inflationary pressure, the RBA has signalled that an extension of the rebates would make a useful contribution to reducing inflation.
Overall, however, the forthcoming federal budget, while not needing to be highly contractionary, should not be expansionary either.
If most economists forecasting persistent high inflation are right and demand is outstripping the economy’s capacity to supply it, why are retail so weak? And why has real per capita GDP declined in the last three quarters after flatlining in the quarter before that?
Australia’s corporate insolvencies are at their highest level in at least a decade - hardly an indicator of an overheating economy.
In making its decisions on the cash rate, the Reserve Bank should ignore the band of economists urging it to increase interest rates even further and instead consider the leading indicators pointing to a deceleration in inflation and a slowing economy.
Craig Emerson is managing director of Emerson Economics. He is director of the APEC Study Centre at RMIT University, a visiting fellow at the ANU and adjunct professor at Victoria University’s Centre of policy Studies.