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Clime time: the RBA isn't independent nor should it be

Confronted by news headlines about the inflation challenge and the battle to bring it under control, reasonable Australians may question both the logic of the proposed monetary policy settings of the RBA and the benign response of the Commonwealth Government.

The rhetoric in the RBA policy suggests that it intends to push interest rates higher and move our economy to the brink, but not into a recession. If only we could believe them!

Meanwhile we observe a complete lack of any counter inflation initiative from the Government. They have wasted a budget bounty (significantly higher than $4.3 billion) created from record export trading. This bounty amounted to a $40 billion budget turnaround in just six months, and it should have rightly been shared with low-income earners with the added benefit of being a counter inflationary policy. It now seems that the budget turnaround caught both Treasury and the Government by surprise and resulted in fiscal policy that is completely wrongly positioned to pull down inflation.

Do we need higher rates?

Australians can rightfully ask as to why, under RBA direction, should interest rates be pushed higher. This inflation fighting policy will have no real influence, given electricity prices (a driver of inflation) are set to rise by more than 20% from 1 July before falling in 2024? Further, what will rising interest rates do to lower the price of oil (petrol) when the supply of that essential commodity is manipulated by an international cartel supporting Russia in its war on Ukraine? Then, more crucially, how can higher interest rates lower the cost of rent when higher rates push up the cost of servicing mortgages of geared landlords?

RBA cash rate

The dogma of “economic group think” are easy to observe by everyone other than economists and bureaucrats. The dogma of economic theory drives thoughtless economic policy settings that belie common sense that suggests that the Government’s fight against inflation should have begun by slowing both wage and price rises. For instance, a calibrated tax adjustment for lower wage earners would have slowed wage push inflation and maintained employment. It will have appropriately checked the RBA’s policy aimed to create job losses. Wage increases outside productivity improvements, would therefore be directly influenced by Government income taxation adjustments.

A better solution

Given the extraordinary Commonwealth budget surplus to be reported for FY23, it is an absolute travesty that the Government did not move quickly to lower the tax rates for low-income earners. If they had then the Fair Work Commission having reviewed this and on the advocacy of the Commonwealth, could have held wages and throttled the likely broader wages push that will no doubt follow. A focused tax cut could have given more money into the hands of low-income workers than the Fair Work decision.

This observation leads me to observe that politicians, bureaucrats, and the ACTU do not understand that take home pay (after tax cashflow) is more important than pre-tax wage increases to an aged care worker, a healthcare worker, a childcare worker, a cleaner or a low-income service provider? Further, the RBA and Treasury do not understand that a recession will increase a fiscal deficit as payments rise with unemployment and tax collections fall. The movement into a fiscal deficit, in reaction to an economic downturn, is not theory –  it is a fact. Therefore, protecting a short-term deficit independent of a strategic economic policy setting is hopeless.

In my view a managed economic downturn by the RBA, in the hope of pushing inflation down, will be much more costly than a thoughtful fiscal policy designed to lower inflation whilst maintaining economic growth. Further, in analysing the components of current inflation it is clear that the proposed rise in electricity prices is based on costs moves of six months ago, that have now reversed. So why support electricity prices higher and add to inflation across the economy when they will be reversed in 2024. That does not make sense!

The outlook for stocks

Self-directed investors are presented with a confusing short term economic outlook that is in contrast to Australia’s position in the fastest growing region of the world. To highlight this point, it is noteworthy that Treasury’s FY23 budget papers forecast that Australia’s major trading partners will grow at over 3 times the projected growth rate of Australia over the next two years.

Adding to the confusion is the observation that long term bond yields in Australia are trading at about 2-3% below reported inflation. Australia’s ten-year bond yield of just below 4% suggests that the bond market is less concerned with inflation than the RBA is. Indeed, it is interesting to reflect that when inflation last lurched above 6% in Australia (2021/22) the ten-year bond yielded 7%. Today’s long-term bonds have a negative ‘real yield’ compared to reported inflation and suggests that inflation will fall.

So, what does this ‘negative real’ ten-year bond yield mean for risk markets and particularly equities? The answer lies in understanding the effect on equity values resulting from the low or negative real returns presented in bond yields.

Normally a recession that flows from higher bond yields (inflation surging) has a significant effect on the value of equities as company earnings fall concurrent with a decline in the price earnings ratio (PER) of the market. However, in this peculiar cycle, with inflation expected to fall no matter what the RBA does, the likely earnings decline of FY24 will not be magnified in the market by a generally lower PER. In other words, any decline in the Australian share market will be moderate. Further, when earnings recover, as they will, given the long-term tailwinds of Australia’s trade and population growth, the market will bounce strongly from higher earnings off elevated PERs.

The RBA isn't independent, get over it

Australians in general, especially low-income earners and investors, must wonder how much better Australia would be if there was a constant and sharp focus on sustainable growth. That growth focus requires our bureaucracies to discuss and develop coordinated policies. In particular they should break away from the dogmatic belief that the RBA must be independent of Government. It cannot be independent because the RBA is the largest single creditor of the Government owning about 40% of Commonwealth Government debt.

 

John Abernethy is Founder and Chairman of Clime Investment Management Limited, a sponsor of Firstlinks. The information contained in this article is of a general nature only. The author has not taken into account the goals, objectives, or personal circumstances of any person (and is current as at the date of publishing).

For more articles and papers from Clime, click here.

 

19 Comments
David
July 23, 2023

Can someone tell me why forcing retirees to take double the pension income from their super compared to the last couple of years is not inflationary? Is it not time the various minimum pension percentages were recalculated based on up-to-date life expectancy data?

Also David
July 25, 2023

There are rumbles that minimum pension percentages will go up, not down... that people aren't spending enough and need to be forced to do so. I can't remember where I read it but probably the Grattan Institute will get onto that one...

Of course, withdrawing and spending are different things, but apparently people are only spending the minimum and if the minimum goes up they'll spend more. Or something like that.

Jack
July 26, 2023

People can be forced to take money out of super, but they can’t be forced to spend it. They can still give it to kids and grandkids.
But money taken out of super is taxed at a higher rate. That’s what this is really about.

Goronwy Price
July 23, 2023

The article is completely incorrect in nearly every aspect. While the rise in the price of oil and other cost increases have been a factor in inflation, the biggest cause has been too much cash in the economy, translating into too much demand. The market is demanding more than we can produce, leading inevitably to rising prices (inflation). It has not just been oil exposed industry. Reducing tax rates would put more money in consumers pockets, resulting in more demand and more inflation. This is exactly what Theresa May got wrong in her brief stint as British PM. To take money out of the economy is the only way either by raising interest rates (monetary policy) or the government raising taxes or reducing spending (fiscal policy). Increasing productivity of course allows us to produce more with the same input, but this takes a long time. Conclusion, the government should have reduced spending much earlier and possibly raised some extra tax, then there would be less inflationary pressure and less need for interest rate rises. The RBA is only doing its job. Just ask the amigos in Argentina if interest rates or high inflation is worst.

John Abernethy
July 23, 2023

Hi Goronwy

You have strongly put the “money supply” theory regarding inflation that has been debased by decades of observation in Japan
( unrelenting QE) and expanding money supply for the decade after the GFC. Remember we could not get even 1% inflation for over a decade across most of the developed world.

The inflation that started ex Covid was supply driven and was added to by energy cost surges ex Ukraine War.

To stop that supply cost inflation spreading to recurring cost inflation across the economy via wages then a lateral response from fiscal policy is needed. A tax adjustment that recovers purchasing power for low income earners lowers wage inflation and does not add to it. However, pushing wages up for low income earners to recoup lost purchasing power starts a wages inflation cycle.

If you think about the recent surge in child care costs it is clearly primarily caused by wage increases of child care workers.

How much better it would have been to cut child care workers taxes, stop wage increases without the need and for the government to increase child care support payments to maintain cashflows to working parents and to stop those same working parents to seek wage increases.


Goronwy Price
July 24, 2023

Expanding the money supply and stimulating economies worked after the GFC to drag world economies out of recession. At some point it had to stop to prevent inflation. Covid delayed that halt, and more funds were added to the pot. Coming out of Covid, we are now paying the price via inflation. The first signs of this could be seen before the Ukraine War and the resultant increase in commodity prices. It was inevitable. The answer when demand is too strong is not to increase it via tax cuts, it is to reduce it by running surpluses either via cutting spending or raising taxes. The less the government does fiscally the more the RBA has to do via interest rates. Japan was a special case, with its declining population, frugal consumers and declining industry.

John Abernethy
July 24, 2023

Hi Goronwy

Heightened Inflation ( surging above targetted inflation) was created when the world came out of Covid, as demand recovered much faster than supply lines could be rebuilt. So demand exceeded supply but not because of money supply but rather because of severely disrupted supply caused by Covid closures.

I don’t think anyone disputes this fact and it led to the common forecast that Covid induced inflation was “transitory” in nature that would fall away as supply recovered.

The emergence of the Ukraine War and the dramatic affect on energy prices greatly added to inflation. This now risks the development of cost inflation caused by a wages push by workers to recover the purchasing power of their after tax wages.

I believe that your arguments are based on a monetarist view of the world that has been greatly discredited by decades of monetary printing or money supply expansion that did not result in consumer price inflation when economic theory suggested that it would.

However, monetarists can take some heart from the asset price inflation that emerged from QE policies and the resultant very low bond yields. However, that is very different inflation to consumer price or cost of living inflation that is the current issue that you and I disagree on how to address.

Michael
July 21, 2023

A very strong article with powerful statements about the inconsistency of actions to rhetoric - most unusual in its directness. Some comments here focus on technical points of funding which misses John's point. It is clear things have happened from Covid on that just do not seem to make much sense. I suggest that when things do not make sense we are looking the wrong way. I do not know the truth but we are not being told it. We live in an age of extreme views and not a lot of listening. I suggest it is fuelled by the untruths and hardly believable scenarios we are constantly fed by authorities.

John Corbin
July 21, 2023

Interesting and pretty pointed article providing alternative solutions to rate rises and Commonwealth (Federal Government) policies. There doesn't deem much, it seems to me, to disagree with on those points. I agree with ye olde former Treasury policy maker on the point of, definition of "independence", though I'm not sure I agree with the portrayal given of the "relationship" between the RBA and the Government. In that respect I agree more with Abernethy. I think then, it is true that the RBA is not "independent" of the Government, because it is constantly in a position of responding to Commonwealth fiscal policy. Now you can question RBA decision making, but in my view not why it is having to make decisions and therefore independence.The other part of the puzzle not covered though is the State budgets. The RBA must surely have regard to fiscal policy there too? Some of them are absolute basket cases.

don
July 20, 2023

The RBA isn't independent!! ------ Who actually owns and controls the bank?

Former Treasury policy maker
July 21, 2023

don, yes it is in terms of setting monetary policy. Compared with the days when the Treasurer had approval of policy decisions (Paul Keating once said that he had them ''in his pocket'') they make decisions without having to get government approval.

In fact this whole article is based upon a misunderstanding of what we in the profession mean by ''independence''. Of course there are relationships between Government and the RBA. The RBA is a statutory authority of the Government and is given its mandate for various activities by the Government. The RBA owns securities issued by the Government and undertakes many banking activities on behalf of government departments.

None of this has ever been what RBA independence means! It's purely about whether they have the authority to make monetary policy changes without getting government endorsement or approval first - and they clearly have that authority.

Straw man arguments like this one really don't help anyone understand what drives decisions about the cash rate.

John Abernethy
July 21, 2023

Given the Treasurer just replaced the RBA Governor with the RBA Deputy Governor when the RBA Governor reapplied for the position, then "Treasurer influence" on behalf of the government over the RBA is clear to observe.

Yes the RBA does set interest rates but we can debate how independent the RBA is when the Governor can be replaced at the discretion of government and given what actually occurred during Covid.

The RBA funded about $300 billion of government stimulation during covid by actively driving bond yields to zero through secondary market purchases that were aggressively flagged to market participants. In my opinion it is hard for anyone to claim that the RBA magically came to that monetary policy decision independent of the fiscal policy set by Treasury and the Government. It was a co-ordinated policy structured in extraordinary circumstances that resulted in (today) the RBA being the biggest single owner of Commonwealth Government bonds.

Did the RBA universally and without direction or discussion with from Treasury or Government decide to drive cash rates to zero and bond yields below 1%? I don't think so.

This is a confronting discussion for current and ex Treasury and RBA officials to undertake and the sooner it is openly discussed then it will indeed help everyone "understand what drives decisions about the cash rate"!





Former Treasury policy maker
July 22, 2023

Did they set rates at zero without direction from the government? You say you don't think so, but you have no evidence to support that. How many of the decision makers at the RBA do you know personally? I know a few.

Did they discuss with the government? Of course they did! This is the straw man nature of your argument. Discussion and co-ordination of policies when the RBA deems that appropriate for monetary policy is not evidence of a lack of independence! They're never going to set monetary policy randomly without the context of economic trends that include fiscal policy moves. Doing so is not a lack of independence.

Happy to have confronting conversations but I prefer to confront facts rather than guesswork and misleading interpretation of straightforward situations. As for innuendo that as a former policy maker I mightn't be willing to engage the issue, well that's the last recourse of someone who knows they're argument is floundering.

John Abernethy
July 23, 2023

Dear Former Treasury Official

I have no idea as to why you are so sensitive to my observations - but the following may help readers.

Given your declared experience and current connections with a few Treasury officials , you will be able to ascertain as to how Treasury got its March 2022 forecast of the FY23 budget outcome wrong by $100 billion? I have pointed this out in various press interviews and as yet Treasury official nor economist will dare touch this issue.

Whilst this is not on point with my current thought piece, I can assure you that I will be reflecting upon this in coming months to continue to investigate economic policy settings and their inconsistencies.

In the meantime if you could investigate that issue and come up with an explanation it would be greatly appreciated. It would be particularly helpful so I don’t have to speculate as to the incompetence of Treasury.

All the best

Former Treasury policy maker
July 23, 2023

John, I'm sensitive because I believe that the move to give the RBA independence from political interference in setting monetary policy was one of the most significant and positive steps we ever took and has brought tremendous benefits to our nation. Your argument that they aren't independent and shouldn't be is part of a misguided chorus of calls to wind that back, to.our detriment.

I care because it matters!

Given that the RBA got policy wrong by keeping super easy policy in place for too long, leading to the inflation we are now battling, a discussion has to be had about what went wrong. But it has to be a discussion based on what their independence actually has been and is.

Not sure why you bring Treasury forecasts in but that proves my point. RBA should have the independence to firm its own views on key macro developments and not be dependent upon the government's own view.

I've said enough on this now. Cheers

Peter PITT
July 20, 2023

You are "Spot On" in this article, BUT politicians don't appear to have commonsense, OR understand what is happening at "Grassroots" level of society.

Roland Geitenbeek
July 20, 2023

The Reserve bank buys bonds from Government, calls these assets on the Reserve Bank balance sheet, prints money, presumably a liability(?), hands this back to the Government which causes inflation and fuels reckless spending...and all the world's experts have played the same game, , almost since the beginning of time and still they do not get it.

Neil Halliday
July 20, 2023

Roland: The RBA does normally buy back government bonds from the primary bond market dealers, if required to do so by the government - but not with "printed money", rather with money raised via auction of government bonds to the private sector.

But in an emergency, the RBA can "print money", eg in March 2020 when the government needed $20 billion per month IMMEDIATELY (to stop people locked in their homes from starving to death..and no time for lengthy bond sales).

Interestingly, when Adam Bandt quizzed Lowe on whether Lowe was 'financing the government", Lowe denied it, even though he WAS creating money out of thin air, until he could organize the sale of bonds in the bond market.

"Smoke and mirrors indeed"; but we now have a $1 trillion debt as a result of the pandemic lock-downs.

The sad thing is Lowe COULD have financed the govrnment for free, without causing inflation because both demand and supply (except for essentials) had been put into enforced hibernation......

Nicholas Chaplin
July 20, 2023

I think this is all generally true and congratulations on a good article which makes important points. I would say, however, that the belief that the RBA should stay independent is not so much focused by many on economics and where an RBA-government cooperation could certainly benefit decision making (especially government decision making) would certainly be an advantage. Most people are concerned with political group-think here and that concern is warranted. We do not need a politicised RBA a la Janet Yellen in the US. Excellent points - just a clarification here.

 

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