Tuesday’s minutes of the Reserve Bank board’s October meeting provide a candid account of the deliberations led by its new governor, Michele Bullock, that resulted in a further pause in the cash rate. But they also highlight the risk that the board will lose its nerve and needlessly hike interest rates even further.
A reading of the minutes suggests an agonising discussion, as board members worried that if they kept the cash rate on hold in coming months then inflation might get away from them, but if they tightened again, it might hammer an already-slowing economy.
Inflation is easing but more so in goods and less so in services. And even among goods, petrol has risen in price which, the board frets, could influence households to increase their inflationary expectations.
Only an eternal optimist would confidently forecast reductions in petrol prices in coming months, considering the distressing situation in the Middle East. But even if higher petrol prices elevated householders’ inflationary expectations, how could these householders express their expectations in their wage claims?
The minutes record that board members noted there were few signs of the risk of a price-wage spiral materialising.
The board would be aware that the damaging wage-price spirals of the late 1970s and early 1980s that were triggered by oil price shocks emanating from conflicts in the Middle East occurred under a centralised wage-fixing system.
Now, under a much more decentralised system, rising petrol prices could lead to a wage-price spiral only if workers were to succeed with claims for higher wages.
Using historical data to estimate a NAIRU and then slavishly jacking up interest rates to achieve that unemployment rate is reckless.
But the board also noted that the labour market had already reached a turning point as labour supply had picked up and labour demand had moderated in a slowing economy. The unemployment rate has risen to 3.7 per cent from its 50-year low of 3.5 per cent, while underemployment has risen a little more.
Fears that the Reserve Bank might be rigidly committed to lifting the unemployment rate to 4.5 per cent might now be quelled. This is the Reserve Bank’s estimate of the Non-inflation Accelerating Rate of Unemployment (NAIRU), which it has considered needed to be reached to prevent a price-wage spiral.
Those fears would have peaked when Bullock, then deputy governor, said in a speech in June that returning inflation to the target range of 2-3 per cent by mid-2025 would involve the unemployment rate rising to 4.5 per cent by late 2024. Bullock said this was not far off some estimates of the NAIRU. It was, in fact, the Reserve Bank’s own estimate of the NAIRU. Worryingly, Bullock described unemployment of 4.5 per cent and inflation back in the target range as being “closer to a sustainable balance.”
If the Reserve Bank still considers increasing the unemployment rate to 4.5 per cent to be achieving “a sustainable balance”, a lot of Australian workers should be worried.
The very idea of using historical data to estimate a NAIRU and then slavishly jacking up interest rates to achieve that unemployment rate is a dangerously reckless idea.
The new Reserve Bank governor has an opportunity to run the NAIRU out of town and she should do so.
After all, the board agreed that inflation had abated from its peak late last year, consumption growth was weak, and households’ real disposable incomes were still falling.
Those don’t sound like the conditions warranting a further interest rate rise on the back of the 12 increases that have occurred since May last year.
Nor should the Reserve Bank board set monetary policy on the basis of poor measured labour productivity. The poor estimated productivity of the last year or so reflects two developments – the employment of less-productive workers who had been struggling for years to find a job, and the further transition of the Australian economy away from capital-intensive goods to labour-intensive services.
We should be celebrating long-term unemployed people finding work, not using further interest-rate rises to return them to the dole queues.
And while smarter ways can be found of delivering services such as teaching, nursing, and aged care, we shouldn’t, for the sake of lifting productivity growth, seek to increase class sizes at schools and reduce the numbers of nurses and aged-care workers in an ageing population.
These are just some of the reasons why the Reserve Bank board should not be using backward-looking estimates of labour productivity in informing its monthly decisions on interest rates.
Further interest-rate rises would worsen the rental crisis by choking off new housing supply. That would increase rents, which would increase the CPI, which would cause the Reserve Bank to increase interest rates, in an economically and socially destructive cycle.
The Reserve Bank board’s minutes signify greater diversity and transparency in thinking. Hopefully, they also mark the embrace of more intuition and less prescription based on outmoded economic theories that rely on highly imperfect data.
Craig Emerson is managing director of Emerson Economics. He is a distinguished fellow at the ANU, director of the Australian APEC Study Centre at RMIT and adjunct professor at Victoria University’s College of Business.