The decision by the Reserve Bank of Australia to raise official interest rates by half a percentage point this week has taken many by surprise. The bank is a notoriously conservative organization. He usually likes to take things in stride. Since he spent last year suggesting that he was unlikely to do anything drastic with interest rates until wages began to rise sharply, his decision to raise interest rates by half a point when real wages fell did not work. be very conservative. Things are changing fast.
While we talk a lot about interest rates in Australia, we don’t talk much about what they are supposed to do in the economy. Economists call the link between interest rates and inflation the transmission mechanism of monetary policy, but it is actually a long list of perhaps.
Everyone knows that when we raise interest rates, people with variable home loans have to spend more on their repayments and, in turn, spend less on other things. But as only about a third of people have mortgages, and many of them have fixed rate mortgages, most Australians are not affected by this link in the transmission mechanism. Fortunately for the Reserve Bank, another third of Australians own their homes and higher interest rates mean that house prices will fall, which the RBA assumes will make them feel less affluent and so much less likely to spend money. Then there are companies that banks assume will invest in less new equipment when interest rates are higher. Again, there may be many, although there is evidence that each of these effects will occur a little, eventually.
“Regardless of the RBA’s goals, when young families have millions of dollars in mortgages and our wealthiest retirees have tens of millions in pensions, small changes in interest rates have huge consequences for the distribution of pain. and the benefits in Australia “.
Precision aside, it’s a safe bet that when interest rates go up, some people and some companies will buy fewer things, and as a result, some companies will stop raising their prices. The result will be lower inflation unless something unexpected happens. Of course, it was unexpected things, not rampant consumer spending, that caused this latest rise in inflation.
For decades, Australians and the RBA have been trained to focus on a form of price pressure known as demand-driven inflation. Rising demand is driving up prices, think of prawns, hotel rooms and Christmas flights, but when unemployment is low, wages are high and companies are making a lot of investment, all this spending it raises the price of everything. Companies use higher prices to ration the things they sell when they are in short supply. When a lot of prices start to go up, the RBA slows down by making us all spend more money on interest payments and less on the things we want to buy.
But Australia’s current inflation spike is not caused by rising consumer demand or rising business investment; it is caused by global increases in the price of energy and a wide range of consumer goods. Economists call cost inflation inflation and, most importantly, hitting the brakes on Australian interest rates will not do much to reduce our inflation when there is a global freight train driving it.
Some commentators have criticized the RBA for not starting raising interest rates earlier this year, arguing that we should have tried to reduce inflation suddenly. But while interest rate policy may be effective against demand-driven inflation, it is powerless in the face of the cost-driven form of inflation that is currently raising the cost of living in Australia. While policymakers like to “do something” in a crisis, the reality is that Australia is in a unique situation and the old scripts about economic management do not fit in with the new economic reality, nor with the thinking of the new government.
Luckily, there is an imminent review of the role of the RBA. While this will do nothing to bring down the price of oil or lettuce, we hope it will help Australia develop a more sophisticated approach to addressing issues as diverse as energy price shocks, chronic low growth wages and the cost of housing in this country. . Meanwhile, the question is what the RBA will do and what it should do in the coming years.
In the short term, it is almost inevitable that the RBA will continue to raise interest rates and, as a result, mortgages will continue to rise, a third of Australians will continue to rise or fall, and many businesses will they will face higher borrowing costs and customers with less money are likely to take a break from their expansion plans.
None of this will stop the war in Ukraine or accelerate the production of silicon chips in China, but it will dampen enthusiasm for profitable price increases in the oligopolies that dominate the Australian economy. Which brings me back to the next review. Energy and silicon chips are not the only thing driving up prices in Australia. The growing profit margins of Australian companies are also playing an important role. Ten years of low-wage growth has, surprisingly, led to 10 years of steady increases in the share of GDP devoted to profits.
While our media is full of stories about companies “having no choice” but to raise their prices, our national accounts are full of evidence that there has never been a better time to be an Australian capitalist. That’s not to say some companies aren’t doing it hard, but it’s time for Australia to stop pretending that because the owner of their local coffee shop is struggling to find staff, Harvey Norman or the Commonwealth Bank need our sympathy.
Much of our current inflation debate revolves around the danger of a wage-price spiral, but with real wages falling faster than at any given time, how could that be a risk?
Australia is in a profit-price spiral, with companies using higher prices for some of their inputs as coverage history for large increases in their profit margins. Yes, cereal prices have risen, but cereals make up a trivial percentage of the retail price of a loaf of bread and wages represent a minority of costs for most Australian businesses.
One thing the next RBA investigation needs to keep in mind is who is on the bank’s board. Although it was previously assumed that the Australian Trade Union Council would be represented, today only business leaders and civil servants have a voice. Given the record low wage growth and the role of profits in boosting inflation, it is clear that it is time for that to change. But while a certain diversity of genuine opinion is good for the government of any organization, the RBA review should also look further.
The Reserve Bank Act of 1959 instructs the bank’s board to conduct monetary policy “to the full advantage of the people of Australia”. Specifically, it commands them to pursue “the maintenance of full employment.” The law makes no specific mention of inflation. Despite this clear legislative obligation, for decades the bank has chosen to prioritize managing inflation over the goal of full employment. To be clear, the RBA believes that if it controls inflation, unemployment will be fixed. It’s like someone who promised to cook dinner saying he thought cleaning the bathroom was a good start.
If the RBA does not want to be responsible for full employment, then the target should be removed from its action. If you want to take responsibility, you should explain what this means in terms of employment and unemployment. Similarly, any revision of the RBA must take into account the broader limits of the effectiveness of monetary policy in a society as unequal as that of Australia. Regardless of the RBA’s goals, when young families have multi-million dollar mortgages and our wealthiest retirees have tens of millions of pensions, small changes in interest rates have huge consequences for the distribution of pain and the benefits in Australia.
While there is nothing the RBA can do to reduce the price of energy or the profit margin of our largest retailers, there is much that a bank review can do to clarify who is responsible for what in Australia. . For decades we have used laws to limit the power of unions and the rights of workers in order to control the imaginary spirals of wages and prices. At the same time, our leaders have been content to rely on competition between oligopolists to control prices and increase profits. Anti-union laws have clearly worked, but competition policy has not.
Also, for decades the generous tax treatment of property has made housing costs higher than almost any other country. This has made the use of interest rate policy a strong and unequal instrument. It is time to look at the whole issue instead of dealing with fiscal and monetary policy separately.
Inflation is not the biggest problem a country can face, but turning high inflation into big cuts in real wages is. Inflation in Australia is not driven by wage growth; it is causing cuts in real wages, so it is time to rethink the role of monetary policy. A review of the RBA’s role has the potential to significantly improve the lives of Australians and the health of our economy, but no matter how soon it arrives, it will do nothing to make it more affordable this winter.
This article was first published in the print edition of The Saturday Paper on June 11, 2022 as “Making bank”.
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