Monetary policy is at a tipping point. If the Reserve Bank board makes the wrong decision next Tuesday or in coming months, it risks plunging the economy into a needless, painful recession.
Yet those advocating the sanctity of an independent monetary policy, above all else, expect the Australian government to play the part of helpless bystander. The Australian people have a different view: at federal elections, they entrust the government to make decisions that are in their interests, not to be passive observers.
Recessions are rarely, if ever, in the national interest.
The key performance indicator of a central banker is to achieve macroeconomic stability, since growth in national prosperity is best achieved when neither inflation nor unemployment is high. But is there a culture in the western world’s central banking community of success being measured by low inflation, even if it is achieved at the expense of throwing large numbers of people out of work and small businesses against the wall?
The mantra of ‘fight inflation first’ seems to be generally accepted among central bankers.
Yet the Reserve Bank’s charter of 1959 gives equal weight to achieving full employment and low inflation.
In fact, the Reserve Bank’s target inflation range of 2-3 per cent was established in 1996 in an exchange of letters between the Howard government and the Reserve Bank governor. There’s nothing wrong with that target range if it doesn’t have to be hit every month of every year.
An inflation rate of 4 per cent is no disaster if it is heading back towards 2-3 per cent, especially if hastening its return to range were to result in a recession.
Every recent statement from the Reserve Bank says inflation is heading down and is expected to reach the top of the 2-3 per cent range in 2025.
Real household disposable income is now falling at its fastest pace on record outside of recessions. More falls are coming, as still large numbers of fixed-rate mortgages will shift onto much higher variable rates.
Real per capita retail spending is falling sharply in response to the rundown of cash balances built up during the pandemic and to 11 increases in the Reserve Bank’s cash rate.
Much of the potency of the sharpest increases in the Reserve Bank’s cash rate in a generation has yet to be felt.
In its public statements of recent months, the Reserve Bank repeatedly refers to walking a ‘narrow path’ of bringing down inflation without causing a recession. Nobody is suggesting this is easy.
But the Reserve Bank appears to believe it has the prerogative to cause a recession if it considers that to be necessary to bring inflation back into the range agreed by the federal government and the governor back in 1996.
A wage-price spiral is mentioned in most of those same statements. A wage-price spiral is everywhere in those statements but not in the data.
Reports of tense exchanges between Labor MPs and Governor Lowe at his parliamentary committee appearance last week appear to be based on the politicians wanting to see wages rise. That is not evidence of a wage-price spiral, and politicians don’t set wages anyway; enterprise bargaining processes and the Fair Work Commission do.
At the Melbourne Economic Forum on Monday, Professor Ross Garnaut demonstrated that the Australian economy had underperformed relative to other western economies in the years from 2013 to the onset of the COVID-19 pandemic. He attributes this to the Reserve Bank’s unnecessarily tight monetary policy during that period stifling growth and employment.
Peter Tulip, formerly of the Reserve Bank, told the forum that Reserve Bank mistakes are rarely challenged internally, or in many cases even identified.
In my view, nothing in the data released since the last cash-rate increase on 3 May warrants a further increase at the Reserve Bank Board’s next meeting. It should pause and allow the 11 inflation-reducing increases of the last year or so to take full effect.
If the Reserve Bank prioritises hastening a return of inflation to the 2-3 per cent range through further monetary tightening it risks tipping the country into recession while the Australian government watches on, helpless to prevent it.
Craig Emerson is managing director 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. Monetary policy was discussed on Monday at the Melbourne Economic Forum supported by the Financial Review.