Inside the huge challenge the RBA is facing right now
Australia has found itself in a very unusual situation right now as the country grapples with two major issues that spell disaster.
ANALYSIS
Australia is in an unusual situation, and so is the world. A real pickle.
Around the world governments rely on monetary policy to keep inflation down. But monetary policy is good at beating inflation only sometimes.
And now is not one of those times.
When central banks like the RBA lift interest rates, that slows down the economy and the inflation rate cools down.
Prices stop going up so much and the downside is slightly higher unemployment. Hooray, usually. But not now.
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Right now, we are in the sort of situation interest rates are bad at fixing: inflation and unemployment are both rising.
Inflation is simply not at the level we would like. The goal is to have inflation between 2 and 3 per cent, but it has not proved easy to keep it stuck in that range.
This problem is not confined to Australia.
In the USA core inflation is over 3 per cent while unemployment is rising to its highest level since 2021 (only 4.3 per cent, which is, to be fair, low by historical standards).
The thing about monetary policy is that it is good at revving up a cool economy: It is powerful at adding growth, inflation and employment when all three are missing.
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And the reverse. It is effective at cooling down an overheating economy, throttling down growth, inflation and employment when all three are starting to feed on each other.
But it is not so good at sending inflation and unemployment in the same direction, i.e. down. Which is what we would like now. If you cut rates, unemployment will go down but inflation won’t.
Shock and therapy
One reason for a scenario like this – higher prices and higher unemployment - can be a price shock.
A good example is when petrol prices went up at the start of the war in Ukraine.
You get high prices and a weaker economy and monetary policy has little it can do about it. In that case, the Treasurer pushed through a cut in petrol tax to help soften the price blow. And that is the big clue about how to solve this dilemma.
When we get trapped in a situation like this we need to take our eyes off the central bank, and off monetary policy. They are useful much of the time, but they struggle more in times like these.
At the moment, petrol prices are not part of our inflation story, by the way. Petrol prices are high, but not rising.
A litre of 91-octane fuel has been fluctuating around $1.80, which is much the same as last year, indeed fuel has fallen 1.7 per cent in price over 12 months, according to the latest official statistics.
We need a way to spark growth and employment in a way that also reduces prices.
In the US, lower tariffs would be one such ploy. In Australia, anything to bring down the cost of building a new house would be extremely helpful.
Housing inflation is high and a big part of that is the cost of building. (Remember: the official CPI excludes land prices and established homes, just measuring the price of the building part of new home sales).
Next CPI will arrive with a bang
In Australia, the next official headline inflation figures comes out next week.
It’s going to be a big deal, especially for anyone that has a mortgage.
ANZ Bank forecasts headline inflation to be above the RBA’s 2-3 per cent range, at 3.1 per cent, and if “trimmed mean inflation” is also above 3 per cent they say to kiss your rate-cut hopes goodbye. Probably until next year.
The RBA meets twice more this year, once in early November, and once in mid-December. Both meetings are likely to pass with no action.
That’s what Commonwealth Bank experts are tipping – no more rate cuts until February. They see headline inflation coming in at 3 per cent next week, not 3.1.
However, they acknowledge the dilemma the RBA is in.
“However, the latest labour force data mean that the decision to hold or cut in November may not be clear cut,” their economists write in a note to clients this week.
The RBA is in a pickle. And the way out of that pickle jar probably depends more on the other parts of government than on them.
Jason Murphy is an economist | @jasemurphy.bsky.social. He is the author of the book Incentivology
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