Sharp deflation is worse than inflation, says RBA’s new deputy governor

Reserve Bank deputy governor Andrew Hauser says Australians need not fear it getting ‘macho’ with interest rates in order to bring down inflation.

Reserve Bank deputy governor Andrew Hauser.

The new deputy governor of the Reserve Bank, Andrew Hauser, has reassured households the bank will not “really go macho” on interest rates to wring inflation out of the economy.

In his first public appearance since taking the reins after a distinguished career at the Bank of England, Mr Hauser said most central banks had learned from the experience of former Fed chairman Paul Volker that sharp deflation was “more costly than inflation”.

While warning that inflation was “incredibly toxic”, he said the RBA was looking to “protect jobs growth”.

The RBA deputy governor was answering questions in a “fireside chat” on Friday at Australia’s Economic Outlook, an annual conference sponsored by Sky News and The Australian.

“Maybe that was true in the Volcker area, for example, in the US, but I think we’ve learned since then and most, if not all, central bank mandates include the idea that if you … really go macho on the growth, you are going to bring inflation down, for sure,” he said.

“But you’re going to keep bringing inflation down – to zero, to negative.”

Inflation is “costly”, but “there’s one thing more costly than inflation, and that’s sharp deflation”. But while jobs growth was “worth protecting”, he said the RBA was not engaged in a “radical strategy”.

The RBA had not lifted interest rates as much as most central banks had done in recent years.

Australia’s inflation rate is at the high end of comparable economies in the developed world. Sweden, Switzerland, Canada and the euro area have started cutting interest rates in recent weeks.

But a policy of sharply increasing interest rates with the aim of causing a sharp slowdown and ­potentially a recession, including higher unemployment to lower inflation, was “not a clear and sensible strategy for any central bank to do” as it could cause deflation, Mr Hauser said.

After cutting its overnight cash rate target from 1.5 per cent to 10 basis points during the Covid-19 pandemic, the Reserve Bank has increased the cash rate target to a 12-year high of 4.35 per cent after inflation hit a multi-decade high around 8 per cent in late 2022.

But while growth sank to 1.1 per cent in the year to March (the weakest since the early 1990s recession apart from the pandemic years), inflation has been above the RBA’s 2-3 per cent target band since late 2021. The monthly inflation indicator has risen from 3.4 per cent to 3.6 per cent this year.

In its latest forecasts in May, which assumed that interest rates would not be cut until mid-2025, the RBA projected that inflation would not be back inside its target band until the end of 2025.

The RBA’s latest forecasts, due to be updated in August, were also made before the subsidies announced in the recent state and federal budgets that will temporarily lower measured inflation.

Mr Hauser said the 2.7 million jobs created in Australia in the past decade was “impressive” versus 2.5 million in the UK, an economy three times bigger than Australia’s.

“It is probably fair to say that there is some secret sauce here that it is worth being particularly protective of. So I would say to that extent that growth as well … the periods of negative growth in Australia [there have been] three quarters. In the UK, I think 12 in the past 20 years’ quarters [have had] negative growth.

“Those are things we’re celebrating, they’re things worth protecting, but this is not some sort of radical strategy off the mainstream, off the grid,” he added in regard to the RBA’s approach.

“This is core central banking … the objective that the Australian people have given us – the ­parliament, the government, the Treasurer – that is crucial because central banks are unelected officials,” Mr Hauser added. “Hopefully we do our job reasonably well, at least some of the time, at least technically. We know what we’re doing, we’re good economists, but we only act under the aegis of the public.

“If the public chooses to give us that task, we must take it seriously. If they take it away, we must take it seriously as well.

“Setting your own goals and saying ‘well, we’re going to do this, we’re going to crush the economy’ … there’s no legitimacy and ultimately central banks will not continue in their role if they set their own goals.

“Those goals are for politicians to set on behalf of the country, and here we have a clear goal which is inflation and to protect those employment gains.”

Australia now faces a “stickier” outlook for inflation, according to UBS Australia chief economist George Tharenou, but he said the RBA was likely to cut rates in February amid cuts by global central banks.

In widely expected decisions, the Bank of Canada and Euro­pean Central Bank cut interest rates this week, following similar decisions last month by the Swiss National Bank and Sweden’s Riksbank.

UBS Australia chief economist George Tharenou. Picture: Hollie Adams

Still, Mr Hauser said the RBA’s job was to “take inflation off the table”. He said: “The same is true if you’re a household. You’ve got lots of challenges in education, your children, bringing your family up, providing for them.

“Having something called ‘inflation’ that you can’t control and gets into every decision is incredibly toxic. I actually think central banks, when inflation picked up a couple of years ago, forgot this ­little period of time, they forgot just how crucial inflation has played a role in long history.

“It’s caused wars, it’s caused genuine breakdown in society, because it is the most unfair form of economic development that you can really think of.

“If you’re on low incomes, if you’re on fixed incomes, if you’re struggling to make ends meet, inflation is a toxic thing you can’t do anything about.”

He said the RBA needed to “give people reassurance” that inflation would come down, rather than predicting interest rate ­levels. Making interest rate predictions was “dangerous” for central bankers.

Mr Hauser also rejected the idea that the economy was “out of sequence” with those of other countries that were now in a position to cut interest rates. “Their interest rates were higher than ours,” he said.

“Their inflation rate is lower than ours, and their unemployment rate has picked up quite a bit more substantially than ours.

“If you took those data out of Canada and you plugged them into the Australian context, you might well see a different policy stance.

“In Europe, which obviously I’ve been a bit closer to in recent years, there has been a very persistent lack of growth.

“Now you might say, Australia has lacked growth in the most ­recent period. But actually, if you compare the aggregate growth rates in Australia to the aggregate growth rates in continental ­Europe, Australia … has had a pretty positive story to tell relative to Europe.”