Time to Reserve judgment

The other day a family member showed me his “man’s shed” in his new house. It has a wall with silhouettes where the tools should be: chisels, fret saws, blade screwdrivers, a tomahawk and the like. I think there was a VCR and vinyl records as well.

It reminded me of the Reserve Bank – last century’s tools. no longer fit for purpose for this century. Except the Reserve Bank has only one tool – interest rates.

We know it is not working. We must ask why. The answer is in two words: baby boomers.

The baby boomers – born in the years immediately after World War II – have, for 70 years – worked their way through the demographic graph like a goat swallowed whole by a greedy python.

Along the way they have cajoled and electorally frightened governments into polices that benefit them – from free university; cheap land; and subsidised mortgages in the 1970s; to superannuation concessions in the 1990s; investment concessions thereafter; and all the while generous senior’s cards giving car rego, utilities and rates concessions to the well-heeled.

The boomers, now in their 70s, are still engaged and articulate enough to make politicians’ lives a misery if those politicians attempt to take away any of these richly undeserved benefits.

The boomers have now left what superannuation funds call the accumulation stage. They are now selling their investment properties and drawing down on their savings.

For them higher interest rates increase their income, through bonds and interest-bearing deposits owned directly or through their funds. Or the increased rates are tax-deductible on investment houses and can be passed on through higher rent.

In this environment, about a third of the economy is unaffected by or benefits from higher rates – and therefore spend more and add to inflation. They spend more because they are used to privilege and having it good.

The other two-thirds are already squeezed to having virtually no discretionary spending left – one sausage with the mash instead two, perhaps. 

The former group balances out the latter. Worse, on the fiscal or budgetary side the Government is headed for deficits which also add to inflation.

In short, the interest-rate tool is not up to the task given to central banks in most democratic market-based economies – to keep inflation and unemployment down while ironing out the boom-bust cycles which have haunted market economies since the industrial revolution.

Central banks got that task and the independence that went with it because politicians could not trust themselves not to misuse the interest-rate tool to help themselves get elected rather than to manage the economy.

We naively believed that if we handed over one of the key levers of economic policy to a central bank we would sail smoothly.

Now to add to this baby-boomer glitch comes some research that suggests that not only are central banks incapable of smoothing out the booms-and-bust curve, but they actually make it worse.

Four European economists argue that central banks themselves cause “boom-bust dynamics” and financial crises by holding rates too low for too long, then lifting rates too far and too fast.

Their paper, Monetary Policy, Inflation and Crises: Evidence from History, trawls through 150 years of data from 17 developed countries. They conclude that central banks add to the boom-bust cycle and, worse, expose economies to financial crises – the very thing they were supposed to avoid.

They say, “Central banks have been raising interest rates to fight inflation just after a period when rates were first cut and then kept low. But these rate hikes substantially increase crisis risk, if rates were previously cut. Rate cuts lead to booms in credit and asset prices, and subsequent rate increases expose these financial vulnerabilities, potentially triggering a crisis.”

Sound familiar? Remember the “recession we had to have”? Remember former Reserve Bank Governor Philip Lowe telling us that interest rates would not rise until at least 2024 and the subsequent astronomic rise in housing prices?

Objectively, the subsequent 13 interest-rate rises in 2023 appear to be specifically aimed at driving Australia into a recession. But I don’t think the Reserve is malicious – just oblivious to other forces at work.

Perhaps the only thing “saving” the Australian economy now is high immigration – but at vast cost to the Australian environment, lifestyle, and amenity of the existing population. Trashing the continent is a poor trade for some good economic figures.

So where to from here? First fiscal policy (Government Budgets) must be used more responsibly and less politically. The inflationary and unfair Stage 3 tax cuts should go.

The great start on the clampdown on corporate tax-dodging should be ramped up further. And the investment concessions mainly used by Boomers should be tweaked away – not like Chris (“They Can Vote for Someone Else”) Bowen before the 2019 election 

And on interest rates we should think outside the square. If the aim is to dampen demand to avoid recession or boost it to avoid a bust, why not use a very direct tool that stares us in the face. We should have a variable GST rate. It would be as effective as a variable speed limit. Every month the Reserve would set the GST rate, rather than the interest rate.

Or the Reserve could have two interest rates: what you pay and what you get. Facing high inflation, the first goes up but the second does not. Facing a bust the first goes down and the second either goes up or stays flat.

In any evet, surely, we can do better than continuing to use last century’s tool kit.

Crispin Hull

This article first appeared in The Canberra Times and other Australian media on 14 November 2023.

3 thoughts on “Time to Reserve judgment”

  1. A variable GST would be fairly complex to administer, but possible if transitions were limited to the start of BAS reporting periods (not monthly) and equitable enough as long as rent and basic foodstuffs are kept GST-free. Even more equitable would be varying the income tax rates for anything above median income. But we’re about to do the exact opposite: give the rich a massive tax cut that will further fuel inflation, so the RBA will take more money off the people with no disposable income left (and give it to the shareholders of the big banks, the same people who are getting the tax reduction).

  2. An analysis of the fiscal budget payments to GDP and the CPI, supports a theory that the inflation rate is influenced by government spending with a 1year delay effect. Starting from 2017-18 payments were 24.63% of GDP and in 2018-19 CPI 1.6% and payments 24.57%; 2019-20 payments 27.75% CPI -0.3%; 2020-21 payments 31.48% CPI 3.8%; 2021-22 payments 26.65% CPI 6.1%; 2022-23 payments 24.79% CPI 6.0%; In the June 23 quarter CPI 0.8% Sept 23 qtr 1.2% (annualised average 4.0%). Quarterly inflation peaked at 2.1% in Mar 22. Conclusion: the Morrison government JOBKEEPER cash splash to employers had an inflationary effect that we are coming off now with lower spending to GDP. Other world economies also splashed cash.

  3. Michele’s picayune interest-rate tweaks are a feeble anachronism, as compared with the inflationary momentum inside “Dr” Jim’s all-time immigration-rates deluge. Which is four to five times higher, than any kind of sanity, as regards electors or the environment. A key reason for over-promoting this RBA lifer, is that she’ll scarcely miaow, anything of the kind.

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