The RBA has lost the plot – monetary policy is now incomprehensible in Australia

It’s Wednesday and I have some comments to make about yesterday’s RBA decision (July 5, 2022) to continue increasing its interest rate – this time by 50 points – the third increase in as many months. If the rhetoric is accurate it will not the last rise by any means. In its – Statement by Philip Lowe, Governor: Monetary Policy Decision – the RBA noted that global factors were driving “much of the increase in inflation in Australia” but there were some domestic influences – like “strong demand, a tight labour market and capacity constraints” and “floods are also affecting some prices”. It is hard to make sense of their reasoning as I have explained in the past. Most of the factors ‘driving inflation’ will not be sensitive to increase borrowing costs. The banks are laughing because while they have increased borrowing rates immediately, deposit rates remain low – result: massive gains in profits to an already profit-bloated sector. But the curious part of the RBA’s stance is that they are defending themselves from the obvious criticism that they are going to drive the economy into the ground and cause a rise in unemployment by claiming that “many households have built up large financial buffers and are benefiting from stronger income growth” – so the increased mortgage and other credit costs will be absorbed by those savings (wealth destruction) allowing households to continue spending. You should be able to see the logic gap – if “strong demand” is driving inflation and that needs to come off for inflation to fall but the buildup of savings will protect demand – go figure. Monetary policy is in total chaos and being driven by ideology. And to calm down after that we have some great music as is the norm on a Wednesday.

The RBA’s irresponsible interest rate rises

The RBA claims that it is increasing interest rates in order to stifle inflationary pressures.

They itemise the factors driving those pressures:

1. “COVID-related disruptions to supply chains” – not sensitive to interest rate changes.

2. “the war in Ukraine” – not sensitive to interest rate changes.

3. High energy prices as a result of the uncompetitive OPEC cartel exercising monopoly power – not sensitive to interest rate changes.

4. “Floods are also affecting some prices” – not sensitive to interest rate changes.

So they are obviously wanting to target:

5. Strong demand – which means they want to bring spending growth down to align with the temporary disruptions in supply.

That isn’t a very sensible strategy because when those temporary disruptions ease what we will be left with is excess productive capacity, unsold inventories, and elevated unemployment.

Then what?

6. “a tight labour market” – it is tighter than it has been but that isn’t really saying anything.

The broad labour underutilisation rate is currently at 9.6 per cent with underemployment at 5.7 per cent.

The underemployed (all 807.3 thousand of them as at May 2022) want to work around 15 hours extra a week.

That is about 345 Full-time equivalent jobs that are needed before that source of labour wastage is eliminated.

Further, the unemployment rate is artificially low at present given the state of overall spending because the external borders have not yet recovered from the closures in 2020-21.

Once the working age population growth recovers with new workers coming in (especially now the Federal government has made the poor decision to allow everyone in without restriction in relation to Covid status) then the labour underutilisation rate will rise given the current state of overall spending growth.

The other point is that wages growth remains low despite the continual claims by business that they cannot attract staff.

I have a solution for them that would give them immediate access to more labour – offer higher wages!

Business tells the RBA that wages growth is accelerating but there is scant evidence of that.

If they really wanted to hire more workers there are 807 thousand underemployed who are desperate for more work.

7. “capacity constraints in some sectors”.

The latest – Monthly Business Survey: May 2022 – from the NAB (published June 14, 2022) – indicates that “Business confidence and conditions both eased in May”.

It also notes that:

Capacity utilisation is now around the record high levels seen just before the Delta outbreak in 2021, which should support investment and hiring over coming months.

Three points:

(a) Capacity utilisation rose from 84.2 per cent to 85 per cent in the month to May 2022. So business still has spare productive capacity.

(b) The record highs previously did not drive inflation (pre Delta).

(c) The signal for business as capacity utilisation tightens is to invest more as the report notes.

Investment has a dual characteristic – it adds to current demand and builds future productive capacity which allows the economy to absorb the growth in nominal spending without creating inflationary pressures.

So the RBA logic seems to be that it wants to choke off business investment because capacity utilisation is rising, which will not only undermine current economic activity but reduce the growth in potential GDP (and makes it harder to grow and reach full employment in the coming period).

Stupid logic.

The bit about household saving

What I found interesting in the statement issued yesterday by the RBA, which just repeated things the Governor has been wheeling out to justify the unjustifiable was the reference to household saving.

The RBA stated yesterday:

One source of ongoing uncertainty about the economic outlook is the behaviour of household spending. The recent spending data have been positive, although household budgets are under pressure from higher prices and higher interest rates. Housing prices have also declined in some markets over recent months after the large increases of recent years. The household saving rate remains higher than it was before the pandemic and many households have built up large financial buffers and are benefiting from stronger income growth.

First, holding out pre-pandemic household saving ratios as some sort of norm is misleading.

The next graph shows the household saving ratio (% of disposable income) from the March-quarter 1960 to the current period.

The following table shows moves in the saving ratio by decades.

Decade Average Household Saving Ratio (% of disposable income)
1960s 14.4
1970s 16.2
1980s 12.0
1990s 5.1
2000s 1.4
2010s 6.4
2020- 15.3

One should also remember that households now have record levels of debt. Nearly 200 per cent of disposable income when in the 1980s the ratio was more like 60 per cent.

So, thinking the current saving ratio is too high and offers households a spending buffer is not responsible in my view.

Second, it is clear the RBA thinks that the buildup of saving by households while spending opportunities were limited during the lockdowns is a spending buffer.

But think about that.

They claim they are raising interest rates to address strong domestic demand (spending).

They obviously know the interest rate rises will do nothing to attenuate the global factors mentioned above.

So it is all about reducing domestic spending.

But then they are open to the criticism that they are deliberately going to create unemployment – and the use the unemployed as pawns in a very inefficient fight against temporary inflationary pressures.

More crudely, they are going to destroy the material prosperity of workers in some hope that will kill demand and force business to narrow profit margins and … whatever else they think will happen.

So to address that criticism they claim – no, wait, households might be squeezed by higher interest rates and rising cost-of-living, but they have a wealth buffer they can run down to fill the gap and maintain spending.

If they maintain nominal spending growth (which isn’t particularly strong anyway) then the interest rate rises will only succeed in destroying household wealth (running down savings) and the so-called domestic inflationary pressures remain.

I could go on teasing out this twisted logic – but I think you will get the picture.

Surgeons attain meaning and function by cutting people up. That is their skill but in most cases is unnecessary and other non-invasive techniques (physio etc) are better options.

Monetary policy functions to push interest rates around. Usually there are better options.

But then what does the central bank do to retain its place in the hierarchy?

That is the problem.

Retail sales growth

Here is a measure of demand – retail sales.

The most recent data was published last week (June 29. 2022) by the Australian Bureau of Statistics – Retail Trade, Australia (May 2022).

The graph shows monthly growth in turnover and as you can see has been declining since the beginning of the year – before the RBA started its current hiking phase.

There were some sectoral differences (Department stores and Cafes, restaurants and takeaway services were both above the aggregate) but total spending on retail goods and services has been in decline.

Growth in credit aggregates

This graph shows the monthly growth in the major credit aggregates since January 2020.

These are the interest-rate sensitive aggregates that the RBA might influence through interest rate rises.

Apart from the on-going speculative binge on investment properties the other aggregates are not accelerating and growth in owner-occupied housing credit has been in decline since May 2021, long before the RBA moved.

The investment housing binge is due to distortions in the tax system that rewards high income earners with massive tax breaks for accumulating multiple properties.

It should be addressed through tax reform.

It is also true that while the rate of change might be levelling off in most categories, the absolute level might be excessive. There is some evidence that the current growth in overall credit is higher than the pre-pandemic.

Dampening housing credit will do little to address the overall inflation rate which is being driven by energy and food prices mostly.

And if one nets out housing then the credit growth picture is more subdued.

If the RBA further dampens non-housing credit growth that will impact on the already weakening retail sales and push Australia towards recession.

My new blog header photo

The photo is from Cape Paterson, Victoria.

I am part of Australia’s most sustainable community development there called – The Cape.

I wrote about it in this blog post – Biodiversity Sensitive Urban Design and the silence of our political parties (May 16, 2022).

This magnificent beach is a short walk through the dunes.

I am planning in 2023 (once buildings are completed) to run Modern Monetary Theory (MMT) workshops through – MMTed – down at the coast, which will also provide training in sustainable living etc.

More details as progress is made on that.

Music – Ryo Fukui

This is what I have been listening to while working this morning.

Last week, I featured one of the great Japanese tenor players – Jiro Inagaki – and I noted a commentator suggested we listen to Ryo Fukui.

I first acquired the album – Scenery – by Japanese jazz pianist – Ryo Fukui – soon after it was released in 1976.

One could get all sorts of albums from the import shop in Melbourne that would not usually come to Australia.

This album was his first release and went largely unnoticed outside the cogniscent jazz circles, which meant, at the time, it was ignored in the US, which was knee deep in disco.

This is the title track – Scenery – and features:

1. Ryo Fukui – piano.

2. Yoshinori Fukui – drums.

3. Satoshi Denpo – Double bass.

Ryo Fukui died in 2016 at the age of 67 and was a great loss.

Here is an interesting account (written just after his death) of how America realised that not everything happens within its own borders – Lost In Time: A retrospective on Ryo Fukui’s ‘Scenery’ (March 24, 2016).

And, if you read Japanese, here is a – Bio.

He was self-taught and didn’t move to the piano until he was 22 years of age and then produced amazing music with his bands.

Next week we might listen to another giant in the Japanese jazz scene, tenor player – Hidehiko Matsumoto. I have one

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.