When the Reserve Bank Board meets this week, it will grapple with an official inflation rate within its target range and its preferred measure – the trimmed mean – just above it. While inflation hawks in the last few months have demanded the Bank increase its cash rate two or three more times, guaranteeing a recession, reasonable people can ask of a cut: if not now, how soon?
An in-vogue term in RBA parlance is that inflation is “sticky.” Really? In less than two years it has fallen from 7.8 per cent to 2.8 per cent. And the monthly annualised reads of the trimmed mean rate are: 4.1 per cent (June), 3.8 per cent (July), 3.4 per cent (August) and 3.2 per cent (September). Down, down, down and down.
Yet the Reserve Bank remains cautious about easing too soon. It’s instructive, therefore, to consider the usual suspects causing the Reserve Bank to hesitate on cutting the cash rate.
The first in the lineup of is the dreaded wage-price spiral. “Not guilty!” this swarthy character indignantly pleads. Although this villain was found guilty as charged several times back in the 1980s, it hasn’t even faced charges in the 2020s, the Reserve Bank Board noting in its minutes a year ago that there were few signs of the risk of a price-wage spiral materialising.
The Bank identified government as a possible villain, fearing Australian consumers would spend their tax cuts that came in on 1 July this year, along with the electricity rebate. But no, not at this stage anyway; they saved most of the extra money.
So which villain is worrying the Reserve Bank Board?
Its prime suspect is a resilient labour market. The unemployment rate has been hovering just above 4 per cent since early 2024, but it just won’t go up to where the Reserve Bank seems to want it. If only businesses would throw some of their employees out of work, seems to be the thinking at Martin Place. Instead, they’re hiring more of them!
This characterisation of the Bank’s thinking is probably unfair, but its concern that the unemployment rate hasn’t risen sufficiently to warrant a cash-rate reduction suggests it remains fixated on reaching its estimate of the non-accelerating inflation rate of unemployment – the NAIRU.
Just a couple of years ago, the Reserve Bank estimated that the NAIRU was 4½ per cent. Since then, the Bank has entertained the possibility that the NAIRU might be closer to 4¼ per cent. But at 4.1 per cent, the unemployment rate might be too low for the Reserve Bank’s liking.
The problem with any such thinking is that the NAIRU is observable only in the past, not in the present or the future. It changes as the economy changes. Not so long ago the Reserve Bank estimated it at above 5 per cent.
If the Reserve Bank insists on holding the cash rate at its present level until unemployment rises substantially it risks plunging the economy into recession. As Michael Pascoe has reflected, based on an analysis of my former Economic Honours Year colleague and former Reserve Bank Assistant Governor, Frank Campbell, the central banks of the world’s major economies began cutting rates well before inflation had reached their targets.
Australia’s annualised quarterly trimmed mean inflation rate is now 3.5 per cent, just 0.5 percentage points above the top of the Reserve Bank’s target range. The US Federal Reserve, the European Central Bank, the Bank of England, the Bank of Canada and the Reserve Bank of New Zealand all began cutting when the gap between the core inflation rate and their target was greater than Australia’s gap.
Moreover, these central banks began easing when inflation was higher relative to their targets than it would be in Australia if the Reserve Bank reduced the cash rate at its November meeting.
What is the Reserve Bank waiting for?
Surely it can’t be worried about allegations that it is the lapdog of the Albanese government.
As Deputy Chair of the House of Representatives Economics Committee, in early 2007, an election year, I asked Reserve Bank Governor, Glenn Stevens, if he would be reluctant to increase the cash rate ahead of the coming election if the data indicated an increase was warranted. He replied that it would be “crazy” to hold off changing the cash rate if the data indicated it should be changed, adding if it had to be done “it will be done.”
It was done and it has been done twice more this century.
If the flow of data continues to indicate the Reserve Bank should reduce the cash rate it should be done.
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 College of Business.