There’s nothing the financial markets and the media enjoy more than speculating about the future of interest rates. And with last week’s news that consumer prices rose by 4 per cent over the year to May, they’re having a field day.
Trouble is, the two sides of the peanut gallery tend to egg each other on. They have similar ulterior motives: the money market players lay bets on what will happen, while the media can’t resist a good scare story – even one that turns out to have scared their customers unnecessarily, thus eroding their credibility.
But the more the two sides work themselves up, the greater the risk they create such strong expectations of a rate rise that the Reserve Bank fears it will lose credibility as an inflation fighter unless it acts on those expectations.
Fortunately, the Reserve’s newly imported deputy governor, Andrew Hauser, has put the speculators back in their box with his statement that “it would be a bad mistake to set policy on the basis of one number, and we don’t intend to do that”.
He added that there was “a lot to reflect on” before the Reserve board next meets to decide interest rates early next month. Just so. So, let’s move from idle speculation to reflection.
For a start, we should reflect on the wisdom of the relatively recent decision to supplement the quarterly figures for the consumer price index with monthly figures.
This has proved an expensive disaster, having added at least as much “noise” as “signal” to the public debate about what’s happening to inflation. Why? Because many of the prices the index includes aren’t actually measured monthly.
Many are measured quarterly, and some only annually. In consequence, the monthly results can be quite misleading. Do you realise that, at a time when we’re supposedly so worried that prices are rising so strongly, every so often the monthly figures tell us prices overall have fallen during the month?
In an ideal world, the people managing the macroeconomy need as much statistical information as possible, as frequently as possible. But in the hugely imperfect world we live in, paying good taxpayers’ money to produce such dodgy numbers just encourages the speculators to run around fearing the sky is falling.
The Reserve has made it clear it’s only the less-unreliable quarterly figures it takes seriously but, as last week reminded us, that hasn’t stopped the people who make their living from speculation.
The next thing we need to reflect on is that our one great benefit from the pandemic – our accidental return to full employment after 50 years wandering in the wilderness – has changed the way our economy works.
I think what’s worrying a lot of the people urging further increases in interest rates is that, as yet, they’re not seeing the amount of blood on the street they’re used to seeing. Why is total employment still increasing? Why isn’t unemployment shooting up?
One part of the answer is that net overseas migration is still being affected by the post-pandemic reopening of our borders – especially as it affects overseas students – which means our population has been growing a lot faster than has been usual after more than a year of economic slowdown.
But the other reason the labour market remains relatively strong is our return to full employment and, in particular, the now-passed period of “over-full employment” – with job vacancies far exceeding the number of unemployed workers.
With the shortage of skilled workers still so fresh in their mind, it should be no surprise that employers aren’t rushing to lay off workers the way they did in earlier downturns. As we saw during the global financial crisis of 2008-09, they prefer to reduce hours rather than bodies.
It’s the changing shares of full-time and part-time workers – and thus the rising rate of underemployment – that become the better indicators of labour market slack in a fully employed economy.
The other thing to remember is the Albanese government’s resolve not to let the ups and downs of the business cycle stop us from staying close to the full employment all economists profess to accept as the goal macroeconomic management.
This resolve is reflected in the Reserve Bank review committee’s recommendation that the goal of full employment be given equal status with price stability, which the Reserve professes to have accepted.
This doesn’t mean the business cycle has been abolished, nor that the rate of unemployment must never be allowed to rise during a period in which we’re seeking to regain control over inflation.
What it does mean is that we can’t return to the many decades where the commitment to full employment was merely nominal, and central banks and their urgers found it easier to meet their inflation targets by running the economy with permanently high unemployment.
The financial markets may persist in their view that high inflation matters and high unemployment doesn’t, but that shouldn’t leave them surprised and dissatisfied with a central bank that’s not whacking up interest rates with the gay abandon they’ve seen in previous episodes.
But there’s one further issue to reflect on. It’s former Reserve Bank governor Dr Philip Lowe’s prediction in late 2022 that we’d be seeing “developments that are likely to create more variability in inflation than we have become used to”. As someone put it: shock after shock after stock.
The point is, it’s all very well for people to say we should keep raising interest rates until the inflation rate is down to 2 per cent or so, but what if price rises are being caused by problems on the supply (production) side of the economy, not by excessive demand?
High interest rates have already demonstrated their ability to end excessive demand, as quarter after quarter of weak consumer spending, and a collapse in the rate of household saving, bear witness. But if high prices are coming from factors other than excess demand, there’s nothing an increase in interest rates can do to fix the problem.
What surprises me is how little attention market economists have been paying to what’s causing the seeming end to the inflation rate’s fall to the target range.
Look at the big price increases that have contributed most to the 4 per cent rise over the year to May – in rents, newly built homes, petrol, insurance, alcohol and tobacco – and what you don’t see is booming demand.
Right now, all we can do to push inflation down is attempt to hide the effect of supply-side problems on the price index by putting the economy into such a deep recession that other prices are actually falling.
This was never a sensible idea, and it’s now ruled out by the government and the Reserve’s commitment never to stray too far from full employment.