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The RBA and the Budget

News, Recent Media Interview, The Australian Economy | 7th April 2022

Saul Eslake talks to Alan Kohler about the outcome of this week’s RBA Board meeting, which foreshadowed the possibility of a first rate rise in June, and about last week’s Federal Budget

AK: And now, here’s Saul Eslake, independent economist and his business is called Corinna Economics. Saul, any surprises in yesterday’s monetary policy decision and statement?

SE: Well, there was no surprise in the decision, of course, but there were some significant changes in the language of the post-meeting statement, which to me suggests that the Reserve Bank’s thinking about increasing interest rates for the first time, sooner than I had expected which had been in August. There was no mention of the board’s preparedness to be patient, as there had been in every statement between November last year and March. Instead, we had an acknowledgement, properly, from the Reserve Bank that there’ll be a further lift in inflation over coming quarters and that there would be a further pickup, albeit only gradual, in aggregate wages growth and broader measures of labour costs.

But what was interesting, was that the Reserve Bank said that over coming months it would assess what it called important additional evidence on both inflation and the evolution of labour costs. I assume that’s a reference to the March quarter CPI that will come out in the last week of April, just before the May board meeting, and the Wage Price Index for the March quarter which will come out in mid-May, but well before the June board meeting. I think what the Reserve Bank board is saying here, is that June is now in play for the first increase in the official cash rate.

I had previously thought and others had disagreed, of course, including the financial markets, that the Reserve Bank board would wait until after the June quarter CPI because most of the increase in the March quarter inflation rate would be attributable to higher petrol cost prices, about which the Reserve Bank board can do nothing and which have a similar impact on the economy to an increase in interest rates so why double up? But my reading of the language in the board statement is that there’s now a real possibility that the first increase in interest rates could come in June.

Some will argue, of course, that the Reserve Bank should raise rates in May but that would be just before the election that seems likely to be held on either the 14th of May or the 21st and it would seem that Phil Lowe doesn’t have any appetite for making the board a subject of political controversy in the way that his predecessor did in 2007.

AK: Yes, so where do you think the interest rates will stop at? How high do you think interest rates will go, the cash rate?

SE: I suspect that eventually the cash rate will get to between 2 and 2.5 per cent, which would imply a standard variable mortgage rate close to 6 per cent, both of which would be considered low by the standards of anywhere prior to the onset of COVID. You remember that during the Global Financial Crisis, the Reserve Bank lowered the official cash rate to what it described as the emergency level of 3 per cent, so I don’t think we’ll get back to there, I don’t think the mortgage rate will get back to where it was just prior to the onset of the Global Financial Crisis, after that increase in interest rates during the 2007 election campaign. Indeed, it may not even get back to the peak which we saw during the last very brief cycle of monetary policy tightening at the height of the resources boom in 2010-11.

But having said that, of course households are carrying a lot more debt in aggregate than they were back then and the Reserve Bank doesn’t need to increase interest rates by as much as it used to in order to have a noticeable impact in dampening aggregate demand.

AK: What did you think of the budget? And I particularly direct your attention to the fact that we’re apparently all doing it tough and need to be bailed out by cash and petrol price excise cuts and so on. What do you reckon, is that correct?

SE: I have no doubt that households at the bottom end of the income distribution, people on pensions and benefits and people who are earning low wages and paying relatively small amounts of tax are, to use that politicians’ favourite phrase, doing it tough. Petrol and food represent a much bigger proportion of the weekly budgets of people on low incomes than they do of people on middle or high incomes, so there’s no criticism from me of the cash payments being made to pensioner and beneficiary households and the top-up to the so-called lamington, the tax rebate that people on low to middle incomes get, indeed arguably there could have been a bit more done for that.

But on the other hand, the vast majority of households, particularly those on middle and upper incomes can hardly be said to be doing it tough. After all, in aggregate households have increased their holdings of bank deposits by more than $250 billion over the past two years, probably very little of that will have been by households at the bottom end of the income distribution. But clearly, some households have got a lot of money in the bank which they could not unreasonably be expected to use to assist them through this temporarily more difficult period.

Moreover, Treasury is forecasting that in real terms private consumption spending will rise by 5.75 per cent in the ’22-’23 financial year. Now, that’s the biggest increase in real household consumption spending since 1973-74 and it doesn’t sit easily with the notion that all Australian households or even a majority of them are struggling with higher petrol and food prices. I mean, no one likes to pay in excess of $100 to fill up their car at the petrol pump and nobody likes to see their grocery bills higher, but except for households at the bottom end of the income scale I don’t think the majority of Australian households are incapable of coping with this without assistance from the Government and in that sense, I think measures such as the reduction in petrol excise, even though it’s only for six months, are poorly targeted and are more a response to populist pressures than they are a genuine attempt to assist those households who really need it…

AK: Well, everyone gets the cut in petrol excise.

SE: Well, that’s right and albeit, it’s only for six months. But, nonetheless, it’s money that in my view could have been better directed elsewhere.

AK: What do you think about the budget overall?

SE: Overall, bearing in mind it is a pre-election budget and it’s inevitable that there will be some pre-election spending and pork barrelling in a budget that comes just before an election, there was less of that than there might have been and there was certainly less of it than there was the last time a Government found itself in similar electoral circumstances and in similar economic circumstances. In the last budget of the Howard Government in 2007 and the months which followed, that Government injected the equivalent of 1.5 percentage points of GDP into the economy in 2007-08 and the equivalent of 2.5 percentage points of GDP in the following two or three years mostly in the form of big income tax cuts, in an attempt to stave off the defeat at the 2007 election that the polls said were looming.

Moreover, there were some parallels with the economic circumstances of that time because that was the last time Australia’s unemployment rate was flirting with 4 per cent. The underlying inflation rate was well in excess of the Reserve Bank’s 2 to 3 per cent target band and the Reserve Bank had actually been increasing interest rates intermittently since 2002. On this occasion, the Government’s policy decisions are providing a stimulus equivalent to about 0.4 of a percentage point of GDP in what’s left of the current financial year and about 0.7 of a percentage point of GDP in 2022-23, most of which is of course in the first three or four months of the coming financial year. After that, it falls away to what’s less than a rounding error.

So, overall, the Government has been more economically responsible than the Howard Government had been at a similar stage of the political and economic cycle and so I welcome the fact that most of the windfall gains from which this Government has mightily benefitted have been applied to reducing the deficit and curtailing the increase in public debt that would otherwise occur. But we still have no indication of any return to surplus, not just over the four years to which the budget forecasts apply, but to the medium-term out to 2032-33 there is clearly no intention of returning the budget to surplus and it’s not going to happen on current policy settings.

AK: No, indeed. Well, great to talk to you, Saul, thanks.

SE: That’s a pleasure, thanks for having me, Alan.


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This chart pack, published on Monday morning (Eastern Australian time) each week, portrays developments in the global economy and in the economies of major nations and regions – the United States, Europe, China, Japan, other East Asian economies, India, Canada, Australia & New Zealand*, Latin America and Central & Eastern Europe – with particular emphasis on:

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