The RBA can’t win its uphill battle against demographics
By continuing to raise the cash rate, the RBA can slow down consumer spending and also push more people into unemployment.
Today we will outline the demographics of interest rates. A demographer talking about economics? You better brace yourself.
Let’s start with the basics. The Reserve Bank is mandated to ensure three things: stability of the currency, full employment, and the economic prosperity of the Australian people. That means the RBA is tasked with keeping inflation in the Goldilocks zone (2 to 3 per cent).
Further the RBA declared the desired unemployment rate to be 4.5 per cent (currently it sits at 3.5 per cent). The third goal of ensuring that Australians are prosperous is surprisingly vague and is usually ignored in public discourse.
Today the RBA finds itself faced with inflation that is higher than their target and employment that is lower than their target.
To achieve its three mandates the RBA has access to a single blunt tool of moving the cash rate up or down. Australian demographics suggest a decade of low unemployment
The skills shortage is going to stay with us despite record high migration intake. We have about a further decade of Baby Boomers retiring. While this big cohort leaves the world of work, just a small cohort enters the labour market. As if this wasn’t enough of an imbalance, the huge Millennial generation will continue to have babies for the next 10-plus years – meaning, the biggest group of employees leaves their job at least temporarily. Finding staff won’t get any easier in the coming decade.
On top of this, the gig economy makes it easy for people to grab a casual job if they are made redundant or if the household needs a quick cash infusion. This pushes at least some people from collecting unemployment benefits to earning a wage and in the process driving down the unemployment rate.
The unemployment rate wants to be super low in the coming decade while the RBA wants to increase unemployment by a full percentage point.
High consumption ahead
The RBA wants us to consume less because lower consumption decreases inflation. The logic is that if high interest rates reduce demand for goods and services, companies can’t raise prices, and inflation goes down. The RBA can just hike rates until inflation settles between 2 and 3 per cent, right? Well, it’s not quite as simple. Here, too, the RBA faces demographic headwinds.
Australians are a lifestyle obsessed people that love to consume. Once in retirement, people are meant to consume less. The current cohort of retiring Baby Boomers are a far cry from the impoverished pensioners of the past. While poor, ageing Australians certainly exist, collectively the group has heaps of savings.
The 65-plus cohort holds 59 per cent of all deposits according to the ABS and CBA. This pile of savings only gets bigger in a high interest rate environment. Is anyone seriously expecting Baby Boomer retirees to sit on their hands and not spend their money?
People in their 30s and 40s, have negative savings as they just bought homes. Their need to consume in the coming decade is big though. They are in the highest spending phase of the life cycle (mid-40s to mid-50s) and every dollar they earn will be spent right away on school uniforms, meals, and mortgage repayments. In wealthier families the Millennial spending is subsidised by Baby Boomer grandparents paying childcare fees or helping with mortgage costs or down-payments.
Rising interest rates disproportionably hurt low-income workers and young Australians. It’s a quick way to widen the wealth gap which is dividing Australia.
What now?
Quick recap, while the RBA wants higher unemployment, demographics push us towards lower unemployment. The RBA wants to slow consumption while demographics push us towards higher consumption. The RBA fights an uphill battle against demographics.
By continuing to raise the cash rate, the RBA will eventually increase unemployment to 4.5 per cent.
The people that would slow their spending are overwhelmingly low-income workers. This cohort, roughly the bottom third of the country, will suffer immensely. Businesses servicing the bottom end of the market would let quite a few people go. The federal government will feel the need to spend big on these new unemployed workers – they can afford to do so considering the recent budget surplus. Such government spending in turn would be inflationary in nature.
By continuing to raise the cash rate, the RBA can slow down consumer spending and can push more people into unemployment. Voila, two of its three mandates are fulfilled only to have wrecked the third mandate of guaranteeing the economic prosperity and welfare of the Australian people.
Something has to give. I am in favour of temporarily dropping the unemployment target of 4.5 per cent. Let the unemployment rate go down as much as it wants (if it was going to go up, interventions would be much more urgent). The full employment target (now defined as 4.5 per cent) was established in times when we were afraid that we couldn’t create enough jobs for everyone. That won’t be a problem now.
A low unemployment rate forces Australian businesses to finally invest big into technology, pushes innovation, increases productivity, and in the process solves a major issue Australia has been shying away from.
Pressure to motivate
The Global Innovation Index 2022 measured innovation-related data in 132 countries. Australia continued its slide down the ranks. Six years ago, Australia was ranked 17. By 2022, we reached 25.
The Harvard Economic Complexity Index wasn’t much kinder. Australia fell from rank 60 in 2000 to rank 93 in the latest edition. It’s fair to say that our easy road to success made us a complacent economy.
Australia urgently needs to embrace innovative technologies to improve labour productivity. Major change only occurs under pressure. Such pressure is not in sight. We make money by selling mining and agriculture products to the world. Prices for both are likely to climb in the coming decades, meaning the same small workforce in these industries is producing more wealth.
Resource wealth is a curse for innovation – we just don’t feel the pressure to do things differently. Record low unemployment forces our businesses to invest and move up the innovation ladder to unlock new opportunities for economic growth.
The RBA’s recent move to halt the cash rate and play the waiting game is a welcome shift in strategy.
Let’s not intervene as long as inflation inches into the right direction (towards 2 to 3 per cent) and let’s ignore the unemployment rate (only in the health and care sector is a low unemployment rate not relatively easily tackled with large scale innovation funding). This way, the RBA’s third mandate of looking after the economic prosperity and welfare of the Australian people might be best served – especially considering that high interest rates only make our continued housing affordability crisis even worse.
Simon Kuestenmacher is co-founder and director of research at The Demographics Group
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