Interest rates are skyrocketing and there are growing fears that a recession may be just around the corner. So why does the RBA do this to us?
As Australia faces the Reserve Bank’s latest interest rate hike, fears grow that the economy is in serious trouble, with falling house prices and even a recession. on the horizon.
It all started in May, when the RBA announced the first official rise in interest rates since 2010, raising the cash rate by 25 basis points to 0.35 percent.
A month later, the RBA shivered again with homeowners with an increase in the “large size” rate of 50 basis points, followed by another jump of 50 basis points this week, with the cash rate now at 1.35 percent.
But now that the shock has begun to fade and Australians are facing the reality of seemingly endless rate hikes to come, the focus is on why the RBA is doing this to us, especially considering that the risks seem so alarming.
Fears of recession
For months, we’ve been hearing that rising interest rates could drive down house prices, with the RBA’s estimate in its latest Financial Stability Review “rising by 200 basis points. of interest rates from current levels would reduce real house prices by around 15 per cent over a two-year period ”.
At the same time, consumer confidence has fallen to its lowest level since the recession of the 1990s, except once at the start of the pandemic, with some families fearing that scared families with less money in the pocket will stop spending completely, which could help. to push the country into recession.
So why is the RBA acting so aggressively?
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Economist Shane Oliver told news.com.au that the RBA was weighing the risks of not doing enough and allowing inflation to spiral out of control, or raising rates now and causing some short-term pain to prevent a worse disaster.
“Rates are going up because inflation is high and it looks like it has gotten worse since May when they started [raising rates], especially with the rising price of energy. Then, they predicted that inflation would reach a maximum of 6 percent, and now they have revised it to 7 percent, ”he said.
“This led to more aggressive increases from June and continued into July, because they are more concerned that the longer inflation stays high, the longer people will wait for it to stay high, which is incorporated into the wage setting. and prices and end in a 70s-style wage price spiral.
“They are adjusting more aggressively, because there is a more serious inflation problem.”
He said if inflation started to slow, the RBA could stop raising rates earlier than expected, ahead of the projected high of more than 3 per cent.
Dr Oliver acknowledged that for many Australians it was confusing to see the RBA continue to raise interest rates amid growing fears of recession and falling house prices.
He noted recent comments from U.S. Federal Reserve chain Jerome Powell, who said the central bank would “tolerate” a recession in order to curb inflation, and said the RBA was trying to balance the risks.
“If we look at the 1970s, there were several recessions and inflation with very weak economic growth, high unemployment and high inflation, and the consensus of that period was that high inflation was quite high. bad for the economy, employment and investment markets. ” He said.
“You could argue that it’s better to go high and cause some pain now, even if it causes a short-term recession, to avoid a repeat of the 1970s.
“If inflation gets out of control, it will lead to worse results than just a recession, so in the long run the country will be better off,” he said. “It seems a little cruel because recessions increase unemployment, but if inflation gets out of control, unemployment could rise for a longer period of time.”
However, he acknowledged that the RBA was taking a risk.
“It’s like touching the brakes of a car, if you keep touching, it will finally stop, and the economy is the same: if you keep raising rates, eventually the economy will stop, and that’s why people are worried about that, ”he said. dit.
“But in the 1970s there was an index of misery that classified inflation and unemployment and found that inflation was as hated as unemployment: unemployment only affects the unemployed, but inflation affects everyone.”
Dr. Oliver said consumer confidence had recently fallen to the levels usually associated with the recession, as rising cost of living already reduced the purchasing power of households as our wages fell.
“Unemployment sounds worse [than inflation]but for the average person who still has a job, it could be argued that high inflation is a bigger problem because it means a lower standard of living and central banks have to value everything, ”he said.
“The RBA is weighing two evils … but they let inflation get out of control, it’s the worst of both worlds: living standards are coming back because you can’t spend more and unemployment is high anyway.”
His fellow economist Chris Richardson accepted that inflation was a “thief in the night” and that when prices move rapidly regularly it caused “all sorts of problems” for people from all walks of life, and that’s why the RBA was fighting him so hard.
“Inflation is bad news for a lot of people: we really don’t want inflation to hold up, so the RBA has to lead the way between two paths, between going too fast and slowing down the economy too much, which it means unemployment will go up.
“Going too slow now could mean higher rates stay longer – one risk is recession and the other is stagnation.
“The question is how much should the Australian economy slow down to make sure we are not caught up in an ongoing problem?”
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