It’s now 57 years since parliament passed legislation setting out the role of the RBA. And we’re all familiar with its three core goals.
They are: the stability of the currency, full employment, and the economic prosperity of all. Yes, broad goals they are. If the RBA could fully achieve one of those goals, let alone all three, we’d be tipping our hats to its 1,200-plus workforce.
The first two goals may in some way be achievable by the blunt hand of monetary policy. But only in part. Surely the third goal — economic prosperity for all — while desirable, can’t amount to much more than a wish.
How do you provide prosperity to ‘all’ by tinkering with rates? They work in opposition to each other: a lower rate helps out the borrowers, but at the expense of the savers. A win for one is a loss for another. The correct balance can only be assessed in hindsight.
For the currency, a higher cash rate means offshore investors bidding up the Aussie dollar as they buy into high-yielding assets, like bonds. And lower rates sees the opposite happen — out the money flows. But how can the RBA juggle it?
It’s all relative; lowering a cash rate by 0.25% won’t make much difference to the money flow if rates are even lower elsewhere. And for a commodity country like Australia, the weight of demand for raw materials could move the currency more than any change in the cash rate.
The subtle hand of inflation
With just the cash rate at its disposal, asking the RBA to achieve ‘full employment’ as a key goal might seem like a pretty big ask.
You’d think that responsibility would lie with the government of the day. It could seek to change employment laws; adjust company tax and/or increase public spending on things from infrastructure through to government services.
But while these issues go back and forth in the politics of the day — and not much changes — the RBA aims to establish the certainty that investors seek by aiming for an average rate of inflation.
And that’s the thing — it’s an aim. Even getting an agreement on what ‘full employment’ actually means is easier said than done. The RBA currently believes full employment is when the unemployment rate is around 5.1%. But quantifying it is a subjective measure.
When it comes to this average rate of inflation, it’s important to understand the ‘average’ part. As Philip Lowe observed recently in his first speech as the RBA governor:
‘Since June 1993, CPI inflation has been below 2% for 24% of the time, and coincidentally above 3% for 23% of the time.’
By averaging inflation in this 2–3% band, the RBA believes it achieves the best public outcome for the economy. That is, a solid footing for investment leading to a sustainable demand for labour. So far, the RBA could argue that it has achieved its aim.
The lever ain’t working
However, the problem for the RBA is that the conventional economic theory on inflation isn’t doing what the textbooks say. Lowering rates is supposed to spur inflation; yet the inflation rate has trickled lower as cash rates have been cut.
If interest rates were higher at, say, something like 6–7%, the RBA would have plenty of scope to pump up demand. An aggressive cutting of rates over successive months could encourage businesses to borrow to invest, putting on additional staff to meet demand.
The problem for the RBA is that the game has changed structurally. Australia was one of the last countries to join the super-low inflation club, but, for the moment, looks like its stay will be a long one.
There are a number of reasons for low inflation.
As Mr Lowe also said:
‘Over the past two years, the price of petrol in Australia has declined by around 20 per cent. This has lowered the year-ended rate of headline inflation by almost 0.4 percentage points over each of these years.’
It’s easy to underestimate how much this lower cost of fuel has taken a chunk out of inflation.
The other issue is food inflation, or, more precisely, a lack of it. Aldi is still building market share, Costco is set to expand, and Woolworths [ASX:WOW] and Coles are slugging it out as they’ve always done. Meanwhile, Metcash [ASX:MTS] is reasserting itself on the side.
Rather than increase prices, these supermarket chains have to make their money by doing more with less. That is, putting even more pressure on suppliers, and carving out efficiencies inch by inch. Not the environment to be asking for a pay rise. For many, just keeping their job is the aim.
These two factors are combining to keep a lid on wage growth. Lower petrol prices have taken out some of the pressure for higher wage demands, as the lower cost is a straight cash benefit to motorists.
And the lack of any meaningful price growth in groceries is also staving off this pressure for pay increases. Although the price of meat has increased, consumers can either buy a lower-grade cut, or simply cut back on the amount of meat they eat.
Another backdrop to this is psychological. There are plenty of people who lost their jobs (or know someone who did) back in 2008–09. It’s not something that’s easily forgotten. For them, the security of a full time position far outweighs the risk of hitting the boss up for a pay rise.
So long as lower bowser prices and stagnant food prices are here to stay, don’t expect a big pick up in wage growth anytime soon. Low inflation leads to low inflation, in a self-perpetuating circle. Low prices keeps the pressure off wage increase demands, which in turn keeps inflation low as well.
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