Life on the West Island - Slow learning

For at least two years, Life on the West Island has questioned the Reserve Bank’s “fight inflation first” strategy of continually raising interest rates. This week, senior economic journalists Glenn Dyer and Bernard Keane agreed:

Insanity is doing the same thing over and over and expecting different results, the cliché goes. At some point, the RBA might wonder, if inflation hasn’t come down despite it repeatedly lifting interest rates, whether it should keep doing the same thing over and over.

The frustration of the Reserve Bank is palpable. It’s deeply annoyed at the way inflation is proving to be resistant to its punitive series of interest rate rises, which have smashed economic growth and forced most consumers to hunker down and run down any pandemic-era savings they might have had left to fund ever-diminishing demand.

In public statements and interviews following this week’s board meeting, senior executives of the Reserve Bank made it clear that they seriously considered yet another interest rate rise and did not contemplate the much-needed rate cut, even though consumer sentiment continues to fall amidst ongoing cost of living pressures. Worse, Reserve Bank governor Michelle Bullock showed that she had learned nothing from the travails of her predecessor after he wrongly predicted that interest rates would not rise for two years – leading to his demise from the job when before long the Bank embarked on an aggressive course of lifting rates. This time, Ms Bullock indicated that there would be no interest rate cuts for at least six months. She seems sure of what will happen to the West Island economy over that time, despite the forecasts from many economic analysts that rate cuts will be necessary soon – and probably before Christmas this year.

The RBA position on fighting inflation is contradictory and flawed. As Dyer and Keane observed:

It’s almost as if the bank was determined to lift interest rates this week and prepared a governor’s statement accordingly, only for the board to shy away at the last moment. That statement listed the usual suspects the RBA likes to blame for inflation: “excess demand”, lazy workers (“wages growth appears to have peaked but is still above the level that can be sustained given trend productivity growth”) and, in the August Statement on Monetary Policy, government spending: “The stronger outlook for public demand reflects ongoing spending and recent announcements by federal and state and territory governments.” That had inflation hawks and neoliberals saying it was all Labor’s fault (ironic, given it’s the only government to produce back-to-back budget surpluses since the early part of the century).

Problem is, the RBA is all over the place on the role of governments in inflation. For instance, in June governor Michelle Bullock made it clear that she would ignore government efforts to reduce headline CPI via methods such as the power bill rebates and increases to Commonwealth rent assistance announced in the May budget and, at the state level, initiatives like the Queensland government reducing public transport fares. Why? Bullock: “we try to look through things that are one-off and are going to be reversed.”

That’s had the endorsement of the economic commentariat and hardline “liquidate them all” economists who think government subsidies are a fundamentally illegitimate way to reduce inflation.

The August Statement demonstrates the impact of those measures from the federal and state governments: headline inflation is expected to decrease to 3% by December and 2.8% by June next year — within the RBA’s target band — but the bank’s preferred measure, the trimmed mean, will still be above 3%. The RBA thinks headline inflation will surge back up again to 3.7% after the end of the current financial year.

So, what consumers will actually be paying is irrelevant — those prices for things like rent and power are just artificial, illegitimate government-subsidised prices, not the real prices of the trimmed mean. Even though you can’t walk into a supermarket and demand to pay in trimmed mean dollars.

But curiously, it’s a different story when it comes to the other side of that coin: the taxes and charges that governments impose on consumers. The RBA treats those as a real part of inflation — even when they generate indexation like we’re seeing now with CPI-indexed excise and taxes that go up because CPI went up in previous quarters, thereby fuelling further CPI rises: the petrol and diesel excise, tertiary education charges, and tobacco and alcohol taxes. Individual federal agencies also index their charges and at the state level, indexation also hits hard: road tolls are indexed to CPI, while stamp and transfer duty thresholds are indexed.

To be consistent on the treatment of government impacts on CPI, the RBA — perhaps working with the Australian Bureau of Statistics — should use a measure of inflation that strips out the impact of self-reinforcing public sector indexation rises — or includes measures designed to reduce CPI. At the moment the RBA happily sees one but “looks through” the other.

But then that would require some deeper thinking about what has really driven inflation in Australia over the last two years. How much of it was the usual neoliberal suspects that the RBA has been blaming: households spending too much and lazy workers getting pay rises — and how much of it is due to factors beyond the control of consumers, no matter how many times the RBA lifts rates.

What this all means is that the Reserve Bank is artificially boosting the rate of inflation on which it bases its decisions on interest rates, apparently using neoliberal economic orthodoxy to include some items which increase the CPI, but ignoring others which lower the rate. Perhaps, then, it is no surprise that the Bank regards inflation as “sticky” and higher than its arbitrary target range of 2-3% per annum. In the process, it is wrecking businesses and making life much tougher for average income earners facing high bills for food and large mortgage repayments.

So, apart from being slow learners on making predictions and continuing to pursue a failing strategy based on questionable statistics, the West Island’s central bank is living in an outmoded era when “fighting inflation first” is failing our nation and its most vulnerable citizens. It’s time for a complete rethink on the role and performance of the Reserve Bank.