The seemingly endless series of interest rate rises by the Reserve Bank of Australia has stirred up arguments about whether monetary policy is the fairest and most effective way to curb inflation.
With the RBA governor, Philip Lowe, expected to announce a record 10th consecutive rate rise on Tuesday, this debate is likely to be inflamed further.
Do we rely too much on lifting rates and might alternatives work better? Here are some key points to consider.
The task: getting demand and supply back into balance
Put simply, inflation results when too much demand is chasing too few goods and services, pushing up prices.
For decades, Australia has relied on monetary policy run by an independent central bank working in tandem with fiscal policy run by governments, particularly the commonwealth, to keep inflation in check and the economy growing.
By the end of 2022, prices were advancing at an annual rate of almost 8%, the most since the early 1990s. Brendan Coates, the economic policy program director at the Grattan Institute, says that “it’s hard to see any policy that you could use to get bring inflation under control that doesn’t involve taking money out of the economy right now”.
But he says options could include “higher interest rates, or spending cuts, or sort of a higher level for saving”.
Is monetary policy ‘too blunt’?
A common refrain is that the RBA’s main anti-inflation policy tool – lifting interest rates – is “too blunt”.
Assuming, as the markets do, that the RBA will hike the cash rate another 25 basis points to 3.6%, a borrower on a typical $500,000 loan will be paying more than a $1,000 extra a month on their debt compared with May last year, data group Canstar says.
Lowe’s predecessor Glenn Stevens argued 15 years ago that monetary policy has been mischaracterised. Sure, higher interest rates do tackle a general increase in prices, but the central bank is ill-equiped to tackle specific price shifts.
“Where are the sharp instruments?” he asked. “It is not obvious that there are all that many.”
Efforts by governments to increase supply – such as the Albanese government’s $20bn “rewiring the nation” plan to expand renewable energy to cut power prices – can work.
“But they are long term,” Stevens said in 2008. “It is hard to deploy them in a hurry. And many of them are very general – ‘blunt’ even – rather than specific.”
Is monetary policy particularly unfair?
If “blunt” were taken to mean “unfair” because rate hikes target households and businesses who have debt, why aren’t there similar complaints when rates fall?
“Presumably the same argument would mean that it is equally unfair to savers to put interest rates down when the economy is weak,” Stevens said.
Coates says a key issue often overlooked in the fairness debate is that wealthier people tend to borrow more than those earning less – and the difference has been increasing, according to data from the Australian Bureau of Statistics.
“Rising interest rates tends to hit higher income earners because they tend to borrow more,” Coates says. “Those are the very bottom, the poorest Australians, don’t have mortgages.”
Whose job is it to fight inflation?
Lowe told a House of Representatives economic committee last month that tackling inflation was “unpopular”, and hence the bank’s independence gave it an edge over politicians when it came to sapping excessive demand in the economy.
“It’s easier for me to do unpopular things than it is for maybe some of you,” Lowe told MPs. “I’m not complaining. It’s our job.”
Governments could cut spending but that move never goes down well with voters, says John Hawkins, a former RBA economist who now teaches at the University of Canberra.
“An alternative would be to have people hand over more money to the government, by raising taxes,” Hawkins says. Scrapping or modifying the Morrison government’s stage-three tax cuts would have a similar effect, but “it is hard for the [Albanese] government to do this as it would seem like them breaking their promise”.
How about compulsory savings?
Besa Deda, St George Bank’s chief economist, says the challenge is to find policy alternatives that can do a better job.
The interest rate rises have started to work, with inflation likely to have peaked in the December quarter and most spending measures starting to slow. In per capita terms, household spending “actually went backwards” compared with the previous quarter, she says.
“I think it’s difficult to find other measures without creating distortions in the economy or without having very long lags,” Deda says.
And federal budgets typically only happen once a year, compared with 11 RBA rates meetings a year.
Governments could, for example, force people to save more by increasing their contribution to superannuation, but that has costs too, Coates says. “You’re probably compromising the degree to which you’re getting people to save optimally – to save the right amount for retirement.”
Hawkins notes that Arthur Fadden, Australia’s treasurer and prime minister in 1941, discussed acting on a proposal by John Maynard Keynes in the book How to Pay for the War. Fadden proposed compulsory loans that would earn 2% interest and be repaid after the second world war as a way to ease inflationary concerns.
“His government, which only lasted 42 days, fell before he could implement it,” Hawkins says, adding that one potential problem of trying that policy now is that the “compulsory saving may just be offset by reductions in voluntary saving”.
How about rent controls and GST hikes?
Deda, who is also Westpac’s business bank economist, says customers have also been asking about the introduction of rent controls. But she says this would deter landlords from adding to housing supply, potentially pushing up rentals for those not benefiting from the controls.
“By introducing that cap, what does that then do to housing supply?” she says.
Hawkins agrees: “They discourage landlords from maintaining the apartments [and] in the longer term discourage their construction.”
The independent senator David Pocock on Monday suggested varying the goods and services tax as a way of moderating inflation. But Hawkins says one problem is that “while a GST hike in the medium term would dampen expenditure and so lower inflation, its immediate impact would be to raise prices”.
“[Another] complication is that the states were promised that the GST would not be changed without their consent.”
Debate has lately flared too over the role of excessive profits in driving inflation higher, as recently assessed by the Australia Institute. The issue has also been raised by the European Central Bank, with policymakers recently showing data that company profit margins had “been increasing rather than shrinking, as might be expected when input costs rise so sharply”, Reuters reported.
Breaking up unhealthy market power, though, will take time, economists said, noting that the RBA’s own charts downplay a build-up of profit’s share of the economy outside the mining sector.
Central banks on ‘auto pilot’
Timo Henckel, a senior economics lecturer at the Australian National University, says central banks had largely been on “auto pilot” for the last few decades when it comes to managing inflation.
Much of the period of what he called the “great moderation” for inflation could be attributed to China’s industrial expansion that sent cheap goods “in every corner of the world”, rather than being the result of “clever domestic monetary policy”.
As Lowe noted in a speech last year, China was in the process of decoupling from globalism and had demographic difficulties of a shrinking population, shifts that would reduce if not reverse previously deflationary pressures.
Henckel says the RBA and other central banks have also been researching how climate change and extreme weather may affect prices and supply chains.
What all this means, he says, is that monetary policy looks likely to be a fertile area of debate and research for a long time to come.
