If there is one lesson our new Reserve Bank governor has not learned from his predecessor, it is the danger of being too specific.
Despite all external calls for transparency and openness, candor, no matter how well-intentioned, can backfire.
Phil Lowe discovered this in the most painful way possible as he tried in vain to support the bank’s immersion into the world of experimental monetary policy by suggesting that interest rates won’t go anywhere for three years.
It seemed like a good idea at the time. The global economy was in chaos and the RBA was buying three-year government bonds in a bid to bring interest rates down to just above zero. Expressing this added weight to the strategy.
But world events caught up with him, inflation awoke from a three-decade slumber, and money markets pushed a steamroller directly onto our central bank and its leader.
In recent weeks, Michele Bullock seems to have dipped a toe into this same trend.
Like almost every other central banker around the world over the past year, she insisted that bringing inflation under control in a timely manner was the top priority. It’s all part of the message to scare horses and punters into cutting back on their spending.
Two weeks ago, however, she added a touch of precision to the message. The RBA, she said, would “not hesitate” to raise rates again if there was a “material” change in inflation expectations.
Lo and behold, when the September quarter inflation figures fell, the numbers were hotter than the RBA’s forecast. This calls into question the central bank’s announced plan to gradually reduce inflation to between 2 and 3% by 2025.
Many are now claiming that the material change clause that was inserted into the dialogue appears to have been triggered and the RBA has no choice but to act on it.
Whether or not you think rates should remain unchanged, the RBA now faces a credibility test. There are only so many times you can make an explicit threat and not follow through without seriously undermining your authority.
Do we really need higher interest rates?
Textbooks are taken off the shelves, opened to the appropriate page with the message repeated at ever-increasing volume.
According to this theory, with inflation still higher than interest rates, our monetary policy is not restrictive enough. In real terms, our interest rates are negative. The only way to solve this problem is to have interest rates above inflation.
If only it were that simple. Our annual growth is declining. If we ignore the effects of our massive population growth, one could argue that we are in a recession. Household spending is falling, building permits are falling at an alarming rate and savings reserves are shrinking.
To top it off, wage growth has remained well below inflation.
As for inflation, it is falling — now 5.4 percent — at a steady pace since peaking at 7.8 percent last December. And many of the factors that helped drive up prices in September’s final quarter data were largely beyond consumers’ control.
Rents soared due to a large immigration program while exorbitant electricity bill increases were imposed during the quarter, which will not be repeated in future quarters. Gasoline prices have also climbed and while they have remained high, it is unlikely that we will see the same type of price rise in the December quarter.
Raising rates again won’t solve any of these problems, and given that the data is backward-looking, it could only tip the economy in the opposite direction.
Why is everyone so confused?
In reality, textbooks only explain how to deal with garden-variety inflation, the kind that happens when we all have too much money and start outbidding each other for goods and services.
This is called demand-pull inflation, and raising interest rates is a powerful tool you can use to bring the situation back under control.
But when it comes to shortages or supply shocks, as we’ve seen in recent years, things aren’t as clear cut. You can raise prices in an effort to slow demand in order to balance supply. There is, however, an increased risk of slowing things down too much.
Our housing and job markets make things even more complicated. It used to be an article of faith that higher interest rates quickly translated into a housing downturn, which would be compounded by mass layoffs as companies struggled to maintain profits.
Not this time. After falling last year, Australian real estate is booming, climbing every month since the start of the year. The record rate of new arrivals could keep demand high.
When it comes to employment, the unemployment rate is incredibly low, at 3.6 percent, with participation rates near a record, despite all the new arrivals.
As long as employment remains strong, the RBA has some leeway in its quest to combat inflation, although history suggests that employment remains strong until the economy slips into recession. .
America eases as hawks urge RBA to step up efforts
Three weeks ago, after US inflation reached 3.7 percent, global markets were convinced that the US Federal Reserve still had a lot of work to do, given that its goal is to bring inflation back to 2 percent, rather than 3 percent.
But last week everything changed. It is now generally accepted that the US has done the heavy lifting and that interest rates will now be held in place after some subtle changes in messaging from the US Federal Reserve.
We went the other way. After keeping rates unchanged for four months, there are increasingly loud calls to raise the official rate on Melbourne Cup day and again, just before Christmas. And this follows the subtle change in messaging from the Reserve Bank.
It’s a question that has also become political. Treasurer Jim Chalmers said after recent inflation data fell that he did not think it represented a “material change” in the inflation outlook. He then explained that he was referring to the Treasury’s forecasts and not those of the RBA.
However, given that Treasury Secretary Stephen Kennedy sits on the RBA board, his comments led to accusations that pressure was being put on what should be an independent central bank, further complicating the decision.
One thing that seems to have slipped under the radar, however, is developments in global money markets.
Despite all the hubbub around official rates, it is what happens in the markets that determines our lives, across mortgages, credit cards, business and personal loans.
Last week, Australian 10-year bond yields rose above US interest rates. That’s right, Australian interest rates are now higher than those in the United States.
This caused the Australian dollar to rise, something Michele Bullock would be very happy with.
But it could all come crashing down with a few careless words.
