As the government prepares its first budget in October, uncertainty about our economic outlook is growing. This is partly because it is increasingly difficult to read the global economy, and there is a growing belief that our interest rates must approach a peak with the Reserve Bank increases. from Australia. It’s also unclear how long the impact of these moves will take to be felt.
In a recent speech, RBA Governor Philip Lowe highlighted the uncertainties against which the central bank is gearing its monetary policy. Lowe is very sensitive these days, facing independent scrutiny and having to admit major errors in his economic forecasts. Indeed, his repeated comment last year that interest rates were unlikely to rise until 2024 prompted accusations of false and deceptive conduct, which the companies acknowledge carries very stiff penalties. They believe that if any of them had made similar misrepresentations on the stock exchange or while selling their products, they would face the full force of the law.
There is also a risk of class action lawsuits arguing that the RBA has a duty of care in the conduct of monetary policy.
In his speech to the Anika Foundation this month, which came a year after his last conversation with the group, Philip Lowe struggled to explain that the magnitude of the rise in inflation compared to what he had predicted a year earlier had “come as a surprise”. The RBA had predicted inflation in 2022 would be just 1.75%, but now expects it to be 7.75%, in what it admitted was “a very big mistake forecast”.
This happened against the backdrop of several years of inflation below 2% and only 1.6% in underlying terms. Today, these figures are 6.1% and 4.9% respectively, and the peak has not yet been reached.
Lowe pointed out that our experience mirrors what has happened internationally – in the United States, Britain, Canada and the Eurozone. His starting point for explaining this “unexpected surge” was the Russian invasion of Ukraine and various energy production problems around the world.
This agrees with the views of other central bankers. The European Central Bank says about three-quarters of the inflation surprise in the eurozone has been unexpected developments in the oil, gas and electricity markets. The Bank of England estimates that rising energy prices will boost inflation by 6.5 percentage points this year.
Our gasoline price has increased 32% over the past year, adding 1.2 percentage points to our overall consumer price increase, as well as some ripple effects from rising fuel prices .
Lowe also asserted that traditional inflation models “face real challenges.” But this focus on the overall output gap – or the extent to which the overall economy is operating below capacity – ignores developments in individual sectors. It also misses the uneven effects of shocks running through them, such as demand surges at a time when supply is reduced due to Covid-19.
A good example of a particular sector effect in Australia is housing construction, where the cost of building a new home has increased by 20% over the past year. This apparently added some 2 percentage points to headline inflation. The very strong demand in this sector has resulted from exceptionally low interest rates and cash injections from the Morrison government and grants of up to $35,000 for some first-time home buyers. This stimulation of the housing market was driven much more by politics than by good economic policy.
These inflation models also focus on inflationary expectations, which Lowe says was not a major factor in our inflationary surprise. Indeed, it refers to market prices which suggest a degree of confidence that our inflation will return to the target range of 2-3%, although the RBA expects it to rise further by then.
The idea of using interest rate hikes as the main instrument of monetary policy in circumstances where supply cost pressures are predominant can be defended as a means of influencing inflationary expectations. That is, the rate hikes demonstrate that the RBA takes inflation control seriously and, more broadly, is willing to attempt to influence the psychology of inflation, despite the likely moderate impact. on request.
The outlook for the global economy is clouded as it is difficult to read the intentions of central banks, which for the most part are also moving towards higher rates to fight inflation. The leader here has been the US Federal Reserve, where Governor Jerome Powell has been clear and decisive in his anti-inflationary strategy and, when necessary, picked up the pace. However, recently some of the Fed’s regional chairs, many of whom also vote on policy, have expressed concern about the pace of hikes, adding to the difficulty of predicting where interest rates will move and whether they will are likely to tip the US economy into recession.
It should be noted that some of the recent stock market improvements have simply been an acknowledgment that central banks are acting against inflation. Along the same lines, the pronounced weakness this week has been driven by concerns that inflation will still turn out higher than expected, as evidenced by the worse-than-expected US Inflation Report, which raises the prospect of even more aggressive rate hikes in the world’s largest economy.
With all the concerns about the pace of the RBA’s interest rate hikes and their likely negative effect on our growth, the most recent figures for the June quarter were generally seen as encouraging. GDP rose 0.9% in the quarter and 3.6% year-on-year as households dipped into their savings – built up during the pandemic, often through direct government support, as well than a large trade surplus – to support their spending. The savings-to-income ratio fell for a third consecutive quarter, from 11.8% to 8.7%, as household spending outpaced growth in household income.
But the economy is still being held back by skills shortages and falling real wages. As the Treasurer said, “It’s a growing economy, but the challenges are also growing.” These challenges include clouds over the sustainability of China’s expansion amid the continued impacts of Covid, a collapsing real estate sector, and a number of significant structural challenges amid slowing global growth.
The real question is what will support growth. We have yet to see the full impact of rising interest rates on households. House prices have fallen across the country and further significant declines are expected based on rate increases to date, and with the RBA suggesting more to come, but perhaps not the big jumps we have. seen in recent months. Evidence is also mounting of significant increases in mortgage stress.
Although consumer spending helped support growth in the last quarter, consumer confidence was not strong. This week there was a slight improvement in the Westpac Melbourne Institute’s Consumer Sentiment Index, which had been falling for around nine months.
A particular challenge for the next budget is for the government to decide how far to go in implementing its election spending commitments to support growth without adding to inflationary pressures, in the context of policy tightening. monetary policy and the need to begin fiscal repair. There are significant opportunities to reduce other spending, in particular by eliminating the Morrison government’s spending largesse through various rorts and grants to partners and donors, as well as closing regional slush and infrastructure funds. of the National Party.
It is now clear that we simply cannot afford the Stage 3 tax cuts, and that is beyond the extent to which they would further aggravate the inequity of the tax system. It is true that Albanese is committed to keeping them, but he has also left himself room for maneuver if circumstances were to change.
Circumstances are now much more difficult than he could have imagined at the time of making this commitment, and the leadership now required is to get down to the level of the Australian people and clarify the government’s priorities: these are those reductions taxes compared to, say, children, the elderly and the disabled. care.
This article first appeared in the print edition of The Saturday Paper on September 17, 2022 under the headline “High Prices To Pay”.
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