“The Australian Financial Review” made an interesting statement in its editorial. Apart from that being unusual in itself, I thought it interesting because of what I inferred from it. When talking about the Reserve Bank’s desire to get inflation back to within the 2-3% range, the paper asserted.
“To make sure this happens, the central bank has one single lever to pull: lifting the overnight cash rate to push up the structure of interest rates and to crimp household spending.”
In other words, there is only one thing that the Reserve Bank can do to get inflation back to within its target range and that’s to raise interest rates and so, logically, it’s going to keep raising interest rates.
This might sound reasonable in the same way that someone could argue that whipping a horse makes it go faster because whipping horses makes them run faster. Of course, in the case of the horse, if the poor animal is just lying there without moving, one would reconsider one’s strategy and check that the animal is not, in fact, dead.
While the increase in interest rates isn’t killing the proverbial horse and – much to the Reserve Bank’s horror – Australians are continuing to spend, the fact remains that the strategy doesn’t seem to be working but, as the Financial Review tells us, it’s the only thing that they can do, so they should do it.
This rather like a dentist saying that removing your tooth won’t fix your acute appendicitis but it’s the only comparable procedure that he’s allowed to perform, so he’s going to do it. And, when it doesn’t work, next month he’s going to remove another one. (Yes, I am aware of the inherent sexism in referring to the dentist as a “he” but I didn’t think making the dentist female when they were doing something absurd was really a triumph in the removal of sexist assumptions.)
The simple fact is that inflation is a complicated beast and, while rising interest rates will suppress demand (at least in theory), and this should take pressure of prices, it’s more complicated than that.
For a start, the rise in interest rates mainly affects people who have money borrowed. This means that some of them are struggling to make ends meet already and further rises will just mean that they find it harder to pay for essentials. Of course, it’s harder to cut back on essentials which means that this will may do little to suppress demand because those struggling have already cut back on their discretionary spending. It simply means that one group of people will just be finding it harder and harder, but this will have limited success in fighting inflation.
Not everyone who’s borrowed money is struggling, of course. Some people will have borrowed money to invest and, if you’ve invested in real estate, you may need to put up rents in order to ensure that your negative gearing isn’t losing so much money that you actually feel it. Again, this will mainly reduce the discretionary spending by the renters, who will often be people who’ve already cut back because of rise in energy costs.
Now the next point is the elephant in the room which is that it’s not the demand from everyday Australians that’s fuelling inflation anyway. It’s coming from the increase in energy prices and disruptions to supply chains.
I’m pretty much going to ignore the energy prices, because I don’t think that even Matt Canavan would argue that interest rate increases in Australia will lead to Putin ending the war, so we’re left with disruptions to the supply chains. These are caused partly by Covid and partly by natural disasters such as the once in a hundred-year floods that are taking place in various locations. Whatever, I can’t see another increase in rates improving the supply chain or doing much to stop weather events. I suppose that if you’re not Matt Canavan and you accept the prevailing wisdom on climate change, a recession may do something to reduce our emissions, ultimately leading to improvements in food production but that does seem like a long bow to draw.
The Reserve Bank seems to be going down a path of: We need to do something, and this is something, so we’ve done what we can.
Whatever, it’s worth noting that Philip Lowe was too busy to give his usual public address after the first RBA meeting of the year, but he did have time to brief traders from the major banks at a private lunch. There is no information about whether he included his CV in the briefing, it seems clear that his desire for another term at the RBA is looking as likely as Josh Frydenberg being the next AFL head, so I guess he shouldn’t be wasting his time with public addresses when there’s a lunch to go to.
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