Reserve Bank rejects ‘scorched earth’ policy to tame inflation with faster interest rate rises

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RBA deputy governor Michele Bullock has said the bank wants to hang on to as much of the employment gains made during the pandemic as it can, even as it tries to cool the economy to tame inflation.

Speaking at an Australian Business Economists dinner last night, Ms Bullock defended the bank’s decision not to raise interest rates more sharply than it had, even though it is now not expecting inflation to fall back below the top of its 2-3 per cent target range until 2025.

“We’re very committed to get it back down to target, but we have a flexible inflation target, and we have a flexible inflation target for a reason,” she told the gathered audience of economists, many of whom work for the big banks.

“In many ways, the easy solution might best be have a scorched earth. And, yes, you could scorch the earth and get inflation back down very quickly. Is that the right thing to do?”

Her answer was a fairly unequivocal no, pointing towards the jobs gains made since the start of the pandemic that have resulted in the highest number of Australians employed on record and the lowest jobless rate in almost 50 years.

“We’ve made some really big gains in terms of employment in the Australian economy,” she said in response to a question from the audience.

“We could crunch the economy very hard and bring inflation down very quickly, but we might lose, we would very likely lose, those gains.”

However, while Ms Bullock was clear that the Reserve Bank would prefer not to have to “crunch the economy” with rate rises, she nevertheless indicated it was prepared to if there were signs inflation was continuing to get worse, not better.

“If we get some particularly bad news on inflation, or wages look like … You know, all the reasons we think we might be different [from other countries] on wages, it turns out we’re not, then don’t doubt our resolve to increase interest rates quite quickly,” she added.

‘Wages growth remains moderate’

Currently, the Reserve Bank appears to have relatively little concern that it will be forced to raise rates more quickly again.

Ms Bullock noted in her prepared speech that wages appeared to be rising faster than the Reserve Bank had anticipated a few months ago, but were still well below the types of gains seen in other countries.

“In liaison, firms in most industries have reported higher-than-average wages growth,” she said.

“Since the middle of the year, close to half of firms reported realised wage increases of 3-5 per cent, with a further quarter of firms reporting increases above 5 per cent.

“New and timely data on wages outcomes for enterprise agreements from the Fair Work Commission shows that average wage increases in newly lodged enterprise agreements were a touch stronger in the September quarter, compared with approved agreements in the June quarter.

“Despite the stronger pick-up, aggregate wages growth remains moderate so far and wage growth expectations generally remain consistent with the inflation target.”

In fact, Ms Bullock said wages growth needs to remain solid to stop inflation from falling back below the target in the longer term, as it had been in the years leading up to the pandemic.

“We still need wage rises in the order of 3.5 per cent to sustain inflation within the band,” she commented during the question and answer session.

While Ms Bullock observed that “there are good reasons to think that we are approaching the peak of inflation this cycle”, she noted the threat that an ongoing surge in energy prices posed next year and beyond.

“The large increases in retail gas and electricity prices that are predicted for next year will directly add over 1 percentage point to headline inflation over the year to September 2023,” she observed.

“Because energy is an input to many of the goods and services we buy, there will also be second-round effects as businesses increase their prices in response.

“These effects are uncertain, but the second-round contribution of electricity prices to underlying inflation could be around half a percentage point over 2024.”

By business reporter Michael Janda (Original ABC Article)