Did the RBA just choose recession?

ABC Listen, podcasts, radio, news, music, and more. The world right now is a disaster. It's easy to feel helpless, but there was a moment when millions of people around the world said enough. I'm Sysankhim Simo. Join me for Boycott, the fight to end apartheid, how Australians joined others around the world to push back against racism and one. Why it's only teams, we thought that too, the average Australian, that would be despicable. Boycott, the fight to end apartheid, search for ABC rewind on ABC Listen or wherever you get your podcasts. To hear the Reserve Bank talk, it's prepared to put Australia into a recession if it has to in order to bring inflation back down. We don't want to have a recession, but if it's hard to get inflation down, then we're going to have to deal with that possibly. Governor Michelle Bollock said she hoped that by lifting rates now, before we come to expect continuing high inflation, she could avoid doing worse damage later. But those of us who use petrol are already suffering damage from relentlessly climbing prices, and it's said to get worse. The Prime Minister has called together the National Cabinet. The Governor acted as if she had little choice but to push up rates this week. But did she? Welcome to the Economy Stupid on ABC Radio National with me Peter Martin, and someone who has helped shape how the Reserve Bank thinks over the best part of two decades. Gianni Likava, who's a former senior research manager at the bank, now with the E61 Institute and Cheryl Murphy, the Oceana Chief Economist for EY, who's also worked at the bank and has tracked its work for the ANZ and the Australian Financial Review, as well as the Australian Trade and Investment Commission. Welcome Gianni, welcome back to Cheryl. Lovely to hear Peter. Thanks for having me. Cheryl, the Governor told us this week on Tuesday that the vote to push up rates with split. Five members of the relevant board voted in favour, four voted against wanting to keep rates on hold for at least a few more weeks. How would you characterize her thinking, the thinking of the majority? So the majority are clearly concerned that the risks to inflation have gotten to the point where they can't sit still, because of the escalation in the conflict in the Middle East, which as we all know has lifted oil prices around the world, and it's already flowing through to some domestic prices. What is it about petrol? I mean, I know it's used for all sorts of things, but does that have a greater significance for inflation than that? Petrol is very visible. It's on our streets. We can see the price of flashing out as we drive along. On my way to record this, I noticed $2.25 in Canberra. It must be the most sign-posted price there is. That's right. We don't see the price of milk changing in front of us in 50 centimetre high, lettering, do we? But a sort of outsized effect then on how we think about inflation, and is that the problem for the Governor? Yes, I think that clearly it is very visible. The political attention on this has been incredible, hasn't it? But I think beyond that, it's much more to do with the genuine flow on effects of higher energy prices into the economy. Of course, the price of petrol goes up, the price of transport goes up. The price of fertiliser is going up, or we'll certainly go up further. That, too, of course, can eventually affect food prices and will have an impact at the supermarket. But more importantly, is the impact on inflationary expectations. Just to give you a little bit of data on this, the ANZ, Roy Morgan, consumer confidence index measures, consumer inflationary expectations. In the last observation, which was just taken over the last week. Just after the strike on Iran. After that, absolutely. Very recent data. It's up at 6.7% now. People are expecting inflation that high when the target is 2.5%. Of course, people always expect higher inflation than we have. Then actual. That's big. That's right. And even if you take the four-week average, it's at 5.8% at the moment, which is the highest since back in 2022 when the economy was firing and really moving along at a very significant pace. Gianni, what do you think the split on the board indicates? We weren't told how board members voted until recently. There was a change mid-last year. This is the closest to a 50/50 split with Sain. What would have been weighing on the minds of those who counseled caution? Who said, "Let's not ramp up rates just yet." I think there would have been agreement on what to do with interest rates, but disagreement on when to do it. It's waiting to say just how big this all-priced shock is going to be. And just how pervasive and persistent it's going to be. I've heard some people talking about COVID 2.0. COVID 2.0. Yeah, I think that would be the sort of thing that we could be talking, especially when. The biggest crisis since COVID. The fact that retailers now have very efficient supply chain, so they hold very little inventory compared to their sales means that when there is a supply chain shock coming along, that can actually lead to big stock at risk. We obviously saw things like toilet paper during COVID. I think anyone that's tried to buy furniture recently will know it can. It's very exciting when you're a purchasing, but it can take three to six months before it gets in the door. These sorts of shocks can emanate quite quickly through the Australian economy. So we've got two things. We've got prices and the reserve bank is under that because it's part of its job. We've also got the threat of the economy really closing down, not only constraining the supply of all sorts of things, but also constraining demand as people lose their jobs or are able to spend in an extreme case down the track. The reserve bank in fact have to cut rates because of the damage that this unfolding crisis does. It's been a real monetary policy roller coaster the last few years with rates going up in 2022 and 23 and then coming down in 25 going up and getting 26 and yet there's the real possibility that they come back down in 2027. I think again it really hinges on just how big and bad things get overseas and how much of that flows through to Australia. The only good thing is that the RBA is buying itself some room to move by moving rates now so that they have. Moving them up so it could move them down. Exactly. And also we have a bit of room to move on things like fiscal policy as well. And putting COVID aside, we still hold that record of nearly 30 years without a recession. So we've got to have some faith that we can manage it, but I think it's a real risk and people will talk about it more over the coming weeks. You see that risk churril of essentially bringing on a recession certainly a becaepeter recession. I think that's probably certain now, but the economy turning down rather than turning up the reserve banks been worried about strength. I mean yes, it's definitely a risk and I was actually a little surprised at how that was underplayed in both the post meeting statement and also the post meeting press conference by the governor. Not to say that I think that there's an imminent risk of recession. I definitely don't. However, it was kind of very much a second-order issue. I will say though that that's also the beauty of monetary policy. It can respond to what's going on in the economy at this point in time, including of course the reserve banks own forecasts. If those forecasts change, then the reserve bank can change course and they've got an opportunity to do that every four to six weeks in this meeting and they could do it in between meetings as well and you know certain emergencies they have and they would. So it's there's no point in preempting something that we don't have any facts to support what they have to do is base their decision on the facts that they have today. That's what they did. So if the facts change and they're for the change dramatically enough, they will change policy. John Maynard Keynes, I think, said, "Yeah, when the facts change, I changed my mind." But it's also the case there, when the facts change in the economy, you can change monetary policy very quickly. And I think we just saw that with the movement from rate cuts to rate increases, as the facts kind of change, it could also happen again. When the facts change, we change our minds here on the economy stupid, as we should, as the reserve bank should. And this might mean that further rate rises under short, or it might. We just don't know. It's what we're trying to find out here on the economy stupid on ABC Radio National with me Peter Martin joined this week by reserve bank watchers and former reserve bank staffers, Cheryl Murphy and Gianni LeCava. Gianni, one question the Governor sidestepped very skillfully at that press conference on Tuesday this week was whether it was government spending or private spending that had been pushing up inflation, forcing the bank to push up interest rates. It's a politically charged question and at the A61 Institute, your views data to arrive at a different market. or complicated answer, it actually knocks some sense into the debate. You've identified, I suppose, a middle way of spending, which is growing, it's called social transfers in kind. What are they? - It's not the most meaningful, understandable term, it's very much a statistical thing, but it's essentially-- - I like it, I like it. - I do, I do. - I think it sounds nice, but I always have to go. - What's the acronym? - Google, it's actually what it's been in here. - It's T-I-K. - Oh, that's good. - Stick is good. But yeah, it's essentially things that consumers, households consume, but essentially funded by the government for either that they're free or they're heavily subsidized. So examples of things like Medicare, the pharmaceutical benefits scheme, childcare subsidies, the NDIS, these all fit under stick or social transfers in kind. - The government funded, but directed by the paper which is to go to the doctor or-- - That's right, I think that's the-- - That's the really nice example of sort of using some of this research, when you visit the GP, the bit that you pay for, the out of pocket expense, that's considered household spending, consumer spending, but the bit that Medicare covers, that's considered government spending. And I think in some sense, that's odd. And when you combine these two things to say, look, this is just one big transaction going to the doctor, you get a very different picture on what's been driving demand in the economy. - What's the implications of that for trying to rein and spending? One I can think of is that the government can't really rein in this sort of spending, not without changing the rules, because it doesn't direct when people decide to go to the doctor, decide to use childcare, decide to use the NDIS. - Now, it's a very difficult thing for us. Yeah, policymakers are both monetary and fiscal. This spending is basically driven by these underlying, factored state demographics. So it's an aging population, it's rising rates of disability, growing need for childcare, changing interest rates doesn't have much for an impact directly on that. So what does it mean if these components are spending going to continue to grow strongly, then the RBA has to clamp down even harder on parts of the economy that are sensitive interest rates. And we know that's things like the housing market and consumer durables. And that does lead to a sort of very difficult communications challenge for the RBA. - It is a really interesting and almost opaque form of spending, isn't it? And I think that the work that Giannis on here is really enlightening. I would say though that if the government really wanted to do something about this, if it was really concerned about the inflationary impact of government spending, it could actually change it. You'd have to take things away though from people. And that, of course, is an incredibly difficult thing to do. It is an interesting debate because should the government always take for granted that these things are just set in stone and never should change in an economy which is changing. - It does mean though, that's it. Gianni, that I will be unlikely to change my behaviour in so far as using childcare or what have you guys just because I have another big chunk of mortgage payments because it's not my money I'm spending most of it. - No, that's right, but. - It'll make interest rates less effective as a tool and perhaps they would have been once. - Yeah, that's one of the implications that monetary policy will be slightly weaker than it was 10, 20 years ago if this is where most of the spending is. The idea is that you will still potentially cut back on other things like maybe you don't go out and buy a car or buy a house or other things that are sensitive to interest rates, but yeah, that's correct. - It's just part of a broader thing, Cheryl and Gianni, that once upon a time the government used to support poor people on the whole by handing cash. These days it's increasingly handing money to everyone in the form of subsidies for services that perhaps this changes sort of crept upon us. - I think it has and it's not bad or good, but it is a kind of a political judgment in a way. So we've gotten into this economy where this sort of share of government in the economy, whether it be through social transfers or actual government spending of things like roads and bridges has definitely been growing. And that's fixing a lot of problems. It's improving the standard of living for some people. There is no doubt about it. We can't complain about this as such, but it does have also have consequences in the sense that there may be, maybe in some areas are sort of a creating out of private sector activity. There may be inflation repressions coming through from some of this and there certainly is a sort of a change in the types of consumption that's going on under our noses, even though we might not even realize it. - I suppose one thing that the government can do, Sherelle is increase taxes. That has the same effect as cutting spending. Indeed, it's got to report this week on the capital gains tax from the Senate. It's likely to wind back those tax breaks. Does the reserve bank do you think need a bit of help from the government to wind back spending? And then I suppose given what we're talking about earlier, is there a problem that if it does that too much, we might be because of the oil crisis heading into a stationary territory anyway and it might need to reverse it? - It is a really tricky dilemma for the government. Isn't it going into this budget and I shouldn't even sneaker at all about this because of course the government would like to help households in this very difficult kind of environment where they're looking at price rises, mortgage increases, which tightening water is probably already quite tight but it's forgotten number of households already. But if they do that, the only thing they're going to do is create more problems because essentially it just means that the reserve bank has to go more heavily on interest rate hikes at the consumer level. There's no sort of two ways about it because the economy only has so much capacity and if you push up against that capacity, you get inflation. The only way you can genuinely fix this is by increasing the productive capacity of the economy. That's where the real lever or the most powerful lever is. But of course it's also one of the hardest and it's slow. - Who'd want to be putting together the federal budget? Well, the Treasurer Award is doing it now. The reserve bank in the meantime has to use the lever it has and we're about to discuss how that lever works on the economy's stupid on ABC Radio National with me Peter Martin and Cheryl Murphy, who's a Shiana Chief Economist for EY and Gianni Likava, who's research director at the E61 Institute. Gianni, this latest mortgage increase will add $100 per month to the scheduled payments for someone on a large mortgage. On top of the $100 per month last time, it's often said that this transmission channel, that the one through mortgage rates, is particularly direct in Australia because so many of us have variable mortgages. But again at E61, you've set out to examine this and found that the transmission mechanism is far more indirect, far more muted than we previously thought. You examine those big interest rate changes in 2022 and 23. What did you find? So what we do is we focus in on the period just after COVID where we saw a big increase in interest rates over 2022 and 2023 and we think about what happened in the context of a, literally like a policy experiment. We've got a treatment group of mortgage borrowers that are on variable rate mortgages so they're going to be exposed to this treatment of higher interest rates. And then you got a control group of fixed rate mortgage people who are not exposed to that treatment. And so what we do with this, a de-identified bank transaction starter is actually fine that as rates went up, the repayments of the people with variable rate mortgages went up a lot compared to the people fixed rate mortgages. But they didn't feed through to their spending at all. They ended up just spending pretty much as much on averages people on fixed mortgages. You know this because of their bank account data. You've looked inside, de-identified and on the mised bank account data and seen that even though people had to pay and did pay more on their mortgages, their other spending changed very little. - Yeah, that was just a shock to me. And I asked the Arrested Tip, can you check that again? 'Cause that contradicts what I found 10 years ago. That's gotta be wrong, I can't be wrong. - That's when you worked for the Serf bank. And you were putting forward this narrative then. - That's right. - We were particularly affected by mortgage rate. - No, what has happened and the way we reconciled is that this was a very unusual time during COVID as we all know. There was a high level of government income support through various payments to households. People couldn't go out and spend because of the restrictions on going out. And also people worried about the future and they were saving a lot. And what's happened is that people have saved up a lot of money in redraw and offset accounts. - I said, how did they necessarily put it in the bank? They've sort of put money in many cases into the home loan but then they can take it out again. - Exactly. And so they can use that to buffer against any increased interest rates. You can just sort of reduce how much you're paying over and above what you expected to pay or you can fund down the buffers that you have. And that is highly unusual across the world. We haven't been able to find another country where these kinds of mortgage products, offset and redraw facilities are used anywhere near as much. And we don't really know why. They are available in New Zealand. They're available in New Zealand. UK, but they're just not as popular as they are in Australia. And if one of your listeners happens to know, the answer I'd love to hear from them, but it's interesting. And it's the thing that has kind of at least during COVID and during a big increase in interest rates, was the thing that protected people spending from their rights, interest rates. Saying that as we go into another period of potentially higher interest rates, when we look at the data, the starting point for people with these big liquidity buffers is quite different. They don't have the buffers that they had during COVID. And so you wouldn't want to see another kind of, you know, 400 basis points of increase in interest rates, otherwise it could get quite nasty. But right at the moment, around the country, people are not after Michelle Bullock's announcement on Tuesday in the other announcement a month or so before people are not having discussions in households on mass about, oh, rights have gone up, we're going to have to cut back our other spending. That's not happening. And if that is not happening, well, that means the Reserve Bank needs, you know, assuming that it, you know, regards this as an important goal, that it needs to push up rates even higher to contain spending. Potentially. There are other, what they call channels of monetary transmission. So other ways that interest rates affect people's spending. You know, it might be the case that it's interest rates go up, house prices fall. People might feel less wealthy as a result of that and spend less. But there could be other reasons, but you're right that if they're not seeing the impact on their cash flow, that it's quite possible that we again won't see much for an impact on spending. What's been your observation, Sherelle, about how responsive we are to interest rate hikes and cuts? I think this research is really important because it does show that this sort of, again, there's underlying changes in the way people think about their cash flow, you know, just may or may not be having an impact. But because of the other channels of monetary policy transmission, though, I suspect that overall it is still working. And at the moment, actually, the exchange rate channel is working really well for the reserve bank. This is when it pushes up interest rates, it pushes up the exchange rate, which makes goods from overseas cheaper. That's right. Exactly. And that can reduce prices or at least put down pressure on price growth. And you might even think about this in the context of your own spending. And if there wasn't conflict in the Middle East, you know, if their currency becomes cheaper, it becomes more attractive to take your holiday overseas than in Australia perhaps. Oh, we won't be getting jet fuel. Don't worry about that. That's true. That's true. This is kind of, it's negated my example to some extent. However, it certainly means that we are buying more things from overseas, though. And in fact, I just noticed in the Westback card data that they made a comment about the fact that a lot of our spending on cards is actually the growth at least in that is in overseas goods. And services not so much in domestic. So I wonder if that's a direct example of the exchange rate channel working quite well. The last big recession we had in the early 1990s was probably caused by the reserve bank going too far. It's been likened to pulling on a brick with a piece of elastic. It doesn't move for a long while, so you pull harder and you pull harder. Eventually it moves and you know about it. It's pretty unpleasant. Is there a risk that the reserve bank will make the same mistake again simply because as it pushes up interest rates, at least for quite a while, we're likely to keep spending as we have been? I have to say the sentiment that I'm reading at the moment is very much that's not the case. The consumer confidence numbers, they were down 4.9% in the last week. That's back to 2020 levels. This has to be to some extent anyway a reflection of not only the fact that the reserve bank has put the cash rate up by 25 basis points two months in row, but there's talk of more and petrol prices have gone up. I mean I do get a sense that people are paying attention to what's going on and I think that that is going to cause just those occasional discretionary decisions to be rethought. Do we get take it on Friday night? Do we book that holiday? Do we buy a new pair of shoes in my case? I like going, yeah, probably not a good idea. So if you want to do the right thing for the country or the right thing for the Gavane, you should perhaps maybe say no to subspanning and then maybe she would not feel the need and her board won't feel the need to push up interest rates high. Ideally, yes. And I might sense the apologies to all my favourite retailers over there. And the thing that I'll be looking at I think will be really key as with a lot of things in Australia is the housing market and how that kind of plays out over the next few months. It would be nice to take some steam out of that. Finally, I know predictions are for mugs, but the Reserve Bank meets again at the start of May just before the federal budget. A quick answer from each of you, please, Cheryl first. Are we likely to see yet another interest rate hike then the third in a row? On balance, I think, yes. I think with the types of changes to forecast that we're seeing in our own numbers and in many of my fellow colleagues in the market's numbers plus the fact that Treasury themselves have made it clear that they're looking at a CPI rate of sort of in the high fours and maybe even in the fives. There is I think every likelihood that the Reserve Bank will act. And remember that the cash rate at 4.1% isn't actually that high. It's probably restrictive, yes. Which it was up at one more from this at 4.35% beginning of or end of 2024. We've been here before. It's not out of the realm of possibility. Gianni, do you see a third right hike in a row? As you say, Peter, I think these forecasts are a bit of a mugs game and I'm particularly muggy I think. I've got the last two interest rates isn't completely wrong. I thought they wouldn't raise rates. So I've obviously been out of the world of central banking for too long. So treat my forecast with a grain of salt. In fact, rather than forecasting what I think they will do, I might say what I think they should do and I think they should actually hold. I just think there's a heightened uncertainty right now, given what's happening overseas. And I think we need a little bit more time to figure out exactly what's happening and whether the effects on activity are going to outweigh the effects on inflation. We know there's a lot that can happen just in a fortnight. It was only a bit over a fortnight ago that the US attacked Iran and I suppose it's six or seven weeks till the next meeting. Thank you both. Before we go anything to look out for in the days and weeks ahead as is traditional Charell. So one thing I've been encouraging everyone but particularly women to look out for is their own finances. There is a substantial difference between men and women. I've recently done some work on this and on every measure on salary, on home ownership, on business ownership, on wealth, on superannuation, on financial literacy. There is a significant gap between men and women and we have to close this and this can't happen in a vacuum. It needs to be done by us all talking about it and women taking a lot of control of their own situation. Jenny, what would you draw attention to? Perhaps not surprisingly. I flagged a little early. I think I'll be watching closely what happens in the housing market. I think it's interesting that it's almost a triple whammy for housing investors over the next little period. We've obviously had the tightening and monetary policy with the increase in interest rates. We've also had a tightening and macro-prudential policy. So the average change is the rules around the size of loans that people can borrow investors in particular. Then with all the talk about what the government might do with the capital gains tax discount, there could be a tightening on that front too. I think all of these things, any one of them on their own, I don't think we'll have a big impact, but putting them all together, that could have a bit of an impact on sentiment amongst housing investors and we know that housing investors have a disproportionate impact on cycles in house prices. So, watching closely what happens in the housing market I think will be important. Thank you, Gianni Likava, research director at the E61 Institute and a former manager of research at the Reserve Bank and Cheryl Murphy, the Oceana Chief Economist for EY, also formally with the Reserve Bank. Thank you both so much. Thank you Peter. Thanks Peter, thanks Cheryl. And thank you for listening. You can find our episodes on the ABC Listen app or on ABC Radio National Thursdays. If you have any thoughts or questions or comments, no economic question is stupid, you can email us. That address [email protected]. I'm Peter Martin. We'll see you next week.