Economic planets may align for Albanese, but not in a good way

The interest rate and global economic cycles are moving into a precarious alignment for Anthony Albanese’s government – threatening Labor’s agenda and even its electoral longevity.

This week’s twin decisions by the Reserve Bank of Australia and the US Federal Reserve to raise interest rates again reinforce an ominous equation for the government. The fight against inflation is reducing the scope for policy innovation in Tuesday’s budget and beyond, while placing a time bomb under the two options the prime minister has for re-election from a position of strength.

Jim Chalmers and Anthony Albanese are constrained by Labor’s small-target electoral strategy and the enduring threat of high inflation.Credit: Alex Ellinghausen

Albanese would be aware that the deadline Reserve Bank governor Philip Lowe has set for taming inflation coincides with a full-term election to be held by May 2025.

As Dr Lowe explained to a business audience in Perth following Tuesday’s RBA board meeting: “We expect inflation to get back to the top of the target range – that’s three per cent – by roughly mid-2025, so that’s the time frame we’re working on. (If) we get inflation back to three per cent in a couple of years and the unemployment rate goes up, maybe to four and a half per cent, my view is that will be a really good outcome for the country.”

There is no margin for error in the RBA strategy. You have to go back to the credit squeeze of 1961 – before any member of the Albanese cabinet was born – for an example when inflation was controlled without undermining the goal of full employment. But that case study still involved a hard landing for the economy, and a savage swing against Robert Menzies’ coalition government at the election in November that year.

Labor people are worried that they could easily fall into minority government at the next election even with a perfect landing for the economy.

The best-case scenario at the moment is that inflation will be subdued, and interest rates lower, when the government is due to go to the polls in mid-2025. The worst case – a recession with soaring unemployment, and still-high inflation – would mean a once-in-a-generation economic crisis for Australia.

Correctly anticipating a recession, Bob Hawke – pictured with then treasurer Paul Keating – went to an early election in 1990. Labor was rewarded with a fourth term in government.Credit: Peter Morris

The last Labor prime minister confronted with the equivalent dilemma was Bob Hawke in 1990. He called an election four months ahead of schedule, in March, and won an historic fourth term. By year’s end, the economy was mired in its deepest recession since the Great Depression.

Albanese might be tempted to think about an early election if the alternative is campaigning in recession in 2025. Yet the option for an election next year following, say, a successful referendum on the Voice, carries its own risks. Both the RBA and Treasury believe the Australian economy will weaken even under the best-case scenario. While neither is forecasting recession, the March quarter of 2024 is considered the most vulnerable quarter for a contraction in gross domestic product. That setback, if it came to pass, would be released in the national accounts in June, immediately after next year’s budget.

The war-gaming of dates for the next election might appear to be an indulgence at this point in the political cycle, especially when the first anniversary of the last election is still a fortnight way, on May 21.

But the options for the next election are an inevitable part of the day-to-day calculations that are made by government and opposition. The fault is in our flexible political calendar. The three-year term for the federal parliament narrows the window for the government to take hard decisions that require time to bear fruit, and for the opposition to engage in policy renewal. There is a reinforcing incentive for risk-averse government, and say-no-to-everything opposition.

The challenge for Albanese’s government is underlined by what Treasurer Jim Chalmers can’t do on Tuesday to help the RBA deal with inflation – raise taxes.

The constraint is, of course, self-imposed; the price Labor was willing to accept last year to ensure that the election was a referendum on Scott Morrison and his government. But it denies the treasurer and his colleagues in the expenditure review committee the opportunity to shift the inflation-fighting burden up the income ladder.

In an ideal world, Chalmers would be preparing a budget that not only trims the stage three tax cuts to apply from July 1 next year, but imposes a short-term levy on higher income earners to help fund cost-of-living relief for lower- and middle-income households. The levy would have been calibrated to ensure that the budget isn’t adding to total demand in the economy. That relief would not need to be focused solely on payments to households. The strongest lever the federal government has in the battle against inflation currently is the one it can pull jointly with the states on energy prices; by reducing the electricity and gas charges faced by households and business via a rebate. That, in turn, would reduce the energy component of the consumer price index.

What Albanese’s government may never know – because it didn’t allow itself to ask the question – is whether it could have secured a grand bargain to repair a tattered social safety net and boost the revenue base. But tax reform is off Labor’s agenda until a second term.

That means that any new spending and cost-of-living relief announced on Tuesday has to be offset with cuts to existing programs – in effect, robbing one vulnerable Labor constituency to assist another. It also ensures that interest rates will be higher for longer than would otherwise have been the case because the revenue side of the budget can’t be deployed to share the policy burden with the RBA.

Dr Lowe insists that a recession can be avoided, even though he concedes that “history teaches us that it is difficult to bring inflation down while keeping the economy on an even keel”.

The history that preoccupies both the RBA governor and the treasurer involves not just our past failures on inflation, but the ultimate cost of success. Punitive interest rates helped to crash the economy in 1975 and again in 1982-3 without defeating inflation. It took a third recession in 15 years – the one Paul Keating said we “had to have” in 1990-91 – to kill inflation.

Lowe and Chalmers have only one shot in the locker between them, and their aim will be guided by what happens to the American economy. The US history is different to ours because the Federal Reserve has been more willing to administer the tough love of a short, sharp recession to deal with inflation.

Lowe has already made allowance for this, in a policy choice that was easy to miss in the shock of this week’s increase in interest rates. Australia cash rate of 3.85 per cent remains more than a percentage point below the US federal funds rate of 5 to 5.25 per cent. The RBA hasn’t pushed rates as high as its peers because it is gambling that the Americans will finish the job for us.

But the history we don’t want to repeat is that of the early 1980s, when the US triggered a global recession to slay its inflation dragon while ours was allowed to roam for another decade.

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