Why new RBA boss must stand up to Labor

Governor of the Reserve Bank of Australia, Philip Lowe, delivering a speech in Sydney.

The key question at the moment is not really whether Reserve Bank of Australia governor Philip Lowe should be reappointed but, rather, who should replace him if his term of appointment is not extended. As they say, everything’s relative.

Let’s be clear: Lowe has made some serious errors, although most of them with the full support of the RBA board. The most egregious was the forward guidance he gave, starting in late 2020, that interest rates wouldn’t increase until 2024. This was not unconnected with the excessive quantitative easing – bond buying – the bank had embarked on during the Covid pandemic.

At a broader level Lowe failed to anticipate the inflationary pressures building in the economy and to take earlier remedial action. This said, it was a nearly universal failing of central bankers around the world to overlook emerging inflation or claim it was merely transitory. They were joined in this view by some of the finest economists – Nobel prizewinner Paul Krugman springs to mind.

But having begun the process of bringing down inflation, it’s clear Lowe has been doing his job well. Moreover, it’s hard to conceive of any other competent governor who would have done things differently. Inflation is a scourge. It has to be tackled head-on. It has to be brought within the target range as soon as possible without inflicting undue short-term economic damage, particularly to those with debt. The real fear is that inflation is now sticky and could become embedded in the system without determined action.

A central issue is whether budgetary policy is doing enough to support the fight against inflation. Lowe rather unconvincingly described the current fiscal settings as broadly neutral at a time when he thought he might hold on to his job.

Philip Lowe and Anthony Albanese

Opposition Treasury spokesman Angus Taylor has made the obvious point that, at this stage, neutral is not good enough; fiscal policy should be actively working to reduce inflationary pressures and this doesn’t mean offering up additional cost-of-living related handouts.

It was noteworthy Finance Minister (and Acting Treasurer) Katy Gallagher was the minister to respond to last week’s decision by the RBA to pause the cash rate.

Last month’s petulant performance by Jim Chalmers had not helped matters; recall his blame shifting and querying of the RBA’s decision. At this stage it’s critical both the government and the bank are on the same page. According to Gallagher, the “government is working alongside the RBA and is not against returning a large portion of revenue upgrades to the budget”. More worryingly, she remarked that “getting the budget back in shape is … a core priority for the government. But we don’t also sidestep the issue that we need to keep an eye on things we can do to support cost of living.”

Katy Gallagher

Anthony Albanese made similar remarks: “We do need to understand … that if the government just splashed money around that would put upward pressure (on) inflation, which would work to counter what the Reserve Bank is doing on monetary policy. We need to make sure that fiscal policy and monetary policy work hand-in-hand and that’s why we have banked most of the savings from the surplus.”

What they fail to understand is that returning large portions of revenue upgrades is not nearly enough. In any case, these revenue upgrades are about to vanish as commodity prices begin to fall and the economy softens, which will reduce the growth of income tax revenue. You only have to look at the budget figures to realise the extent to which this government is cranking up spending, particularly in this financial year compared with last year. (There is a rumour that, in response to the very large unanticipated 2022-23 budget surplus of more than $20bn, the government shovelled out billions of dollars in extra spending in the last few weeks of that financial year – perhaps as much as $7bn. We will know only down the track as the actual figures become available.)

It’s worth taking a close look at the government’s spending plans to understand its reluctance – some would say inability – to implement contractionary, inflation-fighting fiscal policy.

At the time of the May budget, spending for last financial year was estimated to be $632bn or 24.8 per cent of gross domestic product. This financial year it is expected to be $682bn, a real increase of close to 4 per cent from the previous year and making up 26.5 per cent of GDP. Take it from me, the increase of 1.7 percentage points (of GDP) is huge; jumps of this magnitude tend to be associated only with some of sort of economic catastrophe. Note also that the budget spending figures don’t include the off-budget spending – the Rewiring the Nation and the National Reconstruction funds – that will get going this financial year.

If we look at the figures across the four years of the forward estimates, in the final year spending is expected to by $764bn. This will be an increase of close to $150bn compared with the Coalition’s last full year in office – and the budget in that year, 2021-22, was still affected by Covid-related spending.

Of course, it’s not just the spending side of the budget that matters; it is also the bottom line. In the May budget, four deficits in a row were projected, amounting to a cumulative deficit of $114bn. It’s a figure that concerns the bond markets as the traders tend to take a long-term view of the budget situation, calculating the net present values of future spending, revenue and cash balances.

It’s important to recall here that embedded in the budget figures is the crucial assumption that the growth in spending on the National Disability Insurance Scheme would be cut to 8.5 per cent a year, down from more than 14 per cent. The NDIS is the fastest growing spending item in the budget; without this lower figure, the deficits will be higher again.

Bill Shorten

For this reason, it is very concerning that NDIS Minister Bill Shorten remarked that it would not be the end of the world if the assumed lower figure was not met. The Treasurer had to pull him up on this assertion. But without substantial changes to the scheme’s eligibility, it’s impossible to see how the lower figure can be achieved. Shaving small sums off individual plans will simply not meet the new target.

As the countdown begins to the announcement of the new RBA governor, I make two points. First, it would be a serious mistake to appoint a senior public servant to the job, undermining the appearance of independence that was hard fought for. It would be a repeat of the unfortunate Bernie Fraser-Paul Keating experience.

Second, the appointee must have a laser-like focus on dealing with inflation, lest rising prices become entrenched and require even more painful action. In other words, doves need not apply.

The reality is that it’s not sufficient for the government to claim monetary and fiscal policy are working in the same direction; they clearly are not. But fiscal discipline has never been Labor’s strong suit.