Reserve Banks loses leverage

Spare a thought for the new Governor of the Reserve Bank, Michelle Bullock. In the past few days many have reflected on the “mistakes” of out-going Governor Philip Lowe, sometimes comparing him to earlier Governors who seemed to use the interest-rate lever with more finesse.

But the more likely explanation is not that Lowe made “mistakes” by holding rates too high for too long to meet a non-existent wage spiral; holding rates too low for too long fearing an economic crash that did not happen; and then jacking them up too high too quickly.

Rather it is that Lowe’s governorship coincided with changes in the Australian economy that made the interest-rate lever a much less predictable tool. And it will not be any different for Bullock.

Treasurer and later Prime Minister Paul Keating frequently referred to the “economic levers”. Pull or push a lever and the train would speed or slow. You could hand the train over to an independent Reserve Bank to push or pull that lever so the train would not derail but stay on the track.

But the Australian economy is now much less like a train on a fairly predictable track and more like, say, an aircraft requiring a lot more levers controlling not just speed but also sideways and vertical motion.

It is a more complex and different economy. You cannot, as in the past, just increase interest rates and expect household demand to tighten and for firms to respond by decreasing prices to continue to attract custom with a concomitant reduction in inflation.

Several big differences between the 2020s and earlier decades come to mind: Covid; different corporate behaviour; new household sources of money; different consumer responses; and employment arrangements.

Covid taught households to stock up; to save for rainy days; to spend more wisely. But only up to a point, and in erratic and unpredictable ways. The corporate response to Covid was to take advantage of the panic engendered by the fear of not having the full array of goods available immediately. Demand was inelastic: we must have toilet paper; we must have our 4WD; or whatever goods we “need” and we will pay whatever is necessary.

So, prices did not fall in a depressed market, dampening inflation. Rather, savings and other assets were drawn upon and demand went up and so did prices. People bought less, but for higher prices.

Corporate behaviour changed. The obsession moved from “market share” to “shareholder dividends”. In an Australian market full of oligopolies there is no need to pursue “market share” by lowering prices. It is easier to retain profits by keeping prices high while retaining the illusion of competition with the nonsense of pledges to beat any competitor’s price by 10 per cent, or whatever.

Do you know anyone who has successfully tried that?

So, post-Covid, the Covid-era mentality of shortage and of buy-now-at-our-price-or-miss-out lingered.

In this economy raising interest rates was just wheel-spinning in oil. Corporations kept their prices high and households burrowed in to their Covid-era savings and other assets to cop the price rises.

Other factors contributed to the ineffectiveness of the interest-rate lever.

In the relatively buoyant pre-Covid times, households bought a lot of consumer luxuries: TVs in bedrooms; ice-cream makers; boats of all sorts; and so on.

Last century, these items, once bought, were practically worthless. In the new century, though, they could be monetised fairly quickly because of the strength and reach of internet sales sites.

As interest rates went up causing mortgage repayments to rise, households did not suddenly cut consumer spending. They started selling stuff on e-Bay and Gumtree. e-Bay’s Australian turnover shot to $74 billion. 

A good example is the boating market. The turnover of boats in Australia in 2022-23 was $10 billion. People with mortgages and boats, sold their boats. People without mortgages and relatively cashed up bought good used boats because supply-chain stress made new ones impossible to get.

Gumtree is not hugely profitable because it is mostly free, but it converts a huge amount of unwanted consumer goods to cash rather than landfill. That cash helped demand remain relatively high despite interest-rate rises.

These things add up to an increasingly weakened interest-rate lever. They may not seem much, but a just few percent makes the difference between poor or good inflation rates, employment rates, or even polling figures.

Further, retail sales figures suggest that household response to higher interest rates and high mortgage repayments has been to just lower the volume of purchases because there has been no pressure on corporations to lower prices.

As interest rates started to bite in mid to late 2022, total retail sales fell from $36 billion a month to $34 billion against a decades-long trend of increasing. Yet at the same time prices did not fall as a response.

The food part of that was instructive. The total spend flatlined in an environment of increasing prices. It should have resulted in food retailers cutting prices to attract more demand. But no, they kept prices high or increased them knowing the household spend would only flatline, not plummet, and profits would stay high.

None of the big corporate retailers were cutting prices to retain or increase market share so they could retain profits and shareholder dividends. To the contrary, in the absence of competition they all joined in increasing prices so they could increase profits.

It is as if the big retailing corporations sucked up all the loose money and assets in households from Covid savings and small-scale internet monetisation and stuffed it into their profit accounts to give higher dividends and to keep the sharemarket rising.

On the other side of town, the income of those without mortgages and with interest-bearing deposits and shares rose, counter-balancing any dampening of demand and prices on the lower side of town.

Further, higher interest rates are not causing a drop in employment, as happened last century when shedding jobs and greater efficiency and productivity drove profits. This century the oligopolies cannot be bothered with productivity and efficiency when cheap labour abounds and higher prices are tolerated.

The interest-rate levers are no longer effectively connected to the brakes or the engine. We need more than just interest rates to control inflation. We need greater productivity; more competition; a more efficient and equitable tax system; and most importantly the political courage to make the changes.

Good luck, Michelle Bullock, you will need it.

This article first appeared in The Canberra Times and other Australian media on 18 July 2023.