Does the RBA have the right tools for the job?
So the RBA shocked everyone last week when they hiked rates by a double-dose of 50 basis points.
Nobody expected that. Markets were stunned.
The RBA is keen to let us know that it thinks the economy is ‘resilient’ enough to hack it, and that inflation is going to come in much higher than expected.
Dr Lowe said the board would also pay close attention to the global outlook, “which remains clouded by the war in Ukraine and its effect on the prices for energy and agricultural commodities”.
Lowe pointed out that local inflationary pressures are becoming more broadly based. There’s not just the shortages due to the pandemic-related disruption to global supply chains, along with the war in Ukraine, which has pushed up prices for energy and agricultural goods.
But now local demand-side factors are kicking in. Employers are struggling to hire enough workers, which is pushing wagers higher. And gas and electricity prices are also climbing sharply.
As a result, Lowe expects inflation to push higher in coming months, before it eases back towards a more comfortable 2 to 3 per cent range next year.
Ok. But the trouble is we’re talking about two very different things here.
There is inflation that comes from an over-heating economy. When there’s too much money chasing too few goods, prices go up.
Economists call it ‘Demand-pull’ inflation.
But then there’s inflation that comes from the costs of inputs going up (like, you know, electricity prices). As the price of its components goes up, so does the cost and price of the final good.
Economists call this ‘Cost-push’ inflation.
So right now, you arguably have both types of inflation in the mix. The unemployment rate is super-low, households are cashed up, and bottlenecks have reduced the amount of stuff around. Lots of money, too few goods, prices up.
But you also obviously have cost-push inflation too with soaring energy prices.
Now lets think about the one tool the RBA has – interest rates.
Interest rates are great at fighting demand pull inflation. If there’s too much money chasing too few goods, the RBA lifts rates, mortgage rates go up etc, and people have less money, taking some of the heat out of inflation.
So that’s great. Interest rates help with demand pull inflation.
But what do they do with cost-push inflation? What impact will it have on petrol prices or electricity prices if the RBA raises rates?
Absolutely nothing. There’s just no connection. Energy prices are set on the global market, in response to the global supply and demand balance.
What the RBA does with interest rates here in Australia has absolutely nothing to do with it.
So why on earth is the RBA hiking rates to fight energy-price inflation? What good is that going to do?
It’s just going to hurt households at the same time as they’re still getting smashed by rising power prices.
And what really gets me is that I don’t here anyone talking about this. The media just says, “The RBA is raising rates to fight inflation.”
They’re not, they’re raising rates while inflation runs rampant.
My guess is that in six months the RBA wakes up and realises that they’ve made a big mistake.