What Dr Lowe probably didn’t tell the politicians and why
Are you fed up with endless media speculation about inflation, interest rates, wages, jobs, a possible recession, and what governor of the Reserve Bank of Australia Dr Philip Lowe told last month’s parliamentary hearings? Fed up is understandable, but Macks Advisory believes nonetheless you may be fascinated to know what Dr Lowe didn’t tell the politicians – and why.
Obviously, we can’t be sure of this, but we’re offering here an appreciation of probabilities we hope will be helpful in you acquiring an informed view of what’s ahead for the economy.
We believe Dr Lowe didn’t say what he might have said at the parliamentary hearings because it’s scary, and because he’s also aware the RBA is permitted by legislation to do so little to control inflation –- merely fiddle with interest rates. He simply saw no point in antagonising his inquisitors by stating the obvious. Inflation and what will flow from it are essentially government responsibilities.
So, as we make a case for what we think Dr Lowe finds scary and why, stick with us as we begin by reviewing what is known –- including what the RBA governor has been saying outside of parliamentary hearings.
So much is in plain sight
Mortgage payments are rising, real wages and house prices falling (although not in SA), and the world economy is weak. The Economist estimates the interest bill for firms, households, and governments across 58 countries whose economies account for more than 90% of global GDP, is upwards of $10.4trn.
Looking then at this big picture the RBA’s forecast is believable -- that Australia’s economy will slow markedly this year and next, unemployment will rise, but underlying inflation will drop back within an acceptable 2% to 3%.
So, what’s scaring the good doctor? He’s in effect told us. He’s worried high inflation may be “ingrained” in people’s expectations, that these expectations will become self-fulfilling, that businesses will tend to increase prices because they’re expecting everyone else to increase prices, and that unions expecting price increases will campaign remorselessly to get higher wages for workers.
For in a recent media statement, Dr Lowe said: “if inflation does become ingrained in people’s expectations, bringing it back down again is very costly.”
And he said this, knowing full well as we all do, that since the 1970s, ingrained among many influential economists is belief that inflation can only be checked by a recession. So of course, he’s worried.
Wages-prices spiral v. prices-wages spiral
When businesses expect prices to increase, they increase their own prices thus creating a so called “wages-prices spiral” -- for which “greedy unionists” tend to be blamed. Remember the 1970s and 1980s when many unions had the muscle to force employers to agree to big pay rises if they didn’t want to face disruptions to their businesses?
Unions now don’t appear to have the industrial muscle to promote the fights they could then. Furthermore, Inflation these days derives from businesses of all kinds greatly increasing prices to cover jumps in operating costs occasioned by pandemic supply chain disruption aggravated by the Ukraine war.
Recent wage rate increases have increased just a couple of percentage points compared with much higher five to six percentage points in consumer prices, which is why Dr Lowe believes we’re facing problems inherent in a prices-wages spiral not a wages-prices spiral.
It’s why he said in announcing last month’s cash rate rise, that given the importance of avoiding a prices-wages spiral, the RBA board will continue to play close attention to both the evolution of labour costs and the price-setting behaviour of firms in the immediate future.
While Dr Lowe admits that the effect of inflation expectations – that could trigger a prices-wages spiral – are not yet apparent, he’s nonetheless clearly worried when he says, “it’s important that this remains the case”.
But why is he worried increasing inflation expectations leading to a prices-wages spiral could pressure the RBA to keep raising interest rates? What’s he not telling us?
Could it be this?
The RBA board is stacked with businesspeople. Perhaps Dr Lowe is worried they could be inclined to focus on what’s best for business rather than what’s best for the nation?
Perhaps there’s another less cynical explanation he’s disinclined to canvass -- although it’s one being offered by some senior economists – that curbing inflation is not simply a matter of ensuring demand for goods and services doesn’t grow faster than supply.
It’s this. Decades of big firms taking over smaller ones and devising new ways to discourage new firms entering an industry, has left far too many markets dominated by only three or four mega companies -- a situation known as oligopoly.
For example, it looks as though central bankers worldwide have tended to assume no company in an industry can be big enough to influence market price. Thus, they overlook that a prime purpose of companies’ boards who favour oligopoly, is to reach a point where their company CAN be big enough to influence prices.
When only three or four firms dominate a market, it’s easy for their boards to agree to raise prices simultaneously by similar amounts. They then may continue to compete for market share but not on price.
So, could it be that what’s worrying Dr Lowe is that some of Australia’s biggest businesses will be able to keep raising prices even though the RBA’s rate increases have weakened demand.
This would leave him with no other option than to keep raising rates until the economy is beaten into a recession and the nation’s biggest firms are forced to bring prices down.
And so, to conclude
But for Dr Lowe to spell all that out to a committee of parliamentarians -- his predecessors, peers in other central banks, or anyone else – would for him to be willing to state unequivocally that of course
oligopoly and its consequent inadequacy of competition is a significant dimension of inflation. And he’d also have to be willing to admit there’s not a lot the RBA can do about this.
Competition policy is a responsibility of the Australian Competition and Consumer Commission (ACCC) not the RBA, and since the RBA has been increasing interest rates, the Big Four banks’ profits have soared – probably Australia’s best example of oligopolistic pricing power.
They’ve exerted this power by passing rate increases on to borrowers while being reluctant to increase depositors’ interest rates – that is raising the price of loans while declining to pay depositors a comparable higher interest rate for their money.
If you’re a depositor don’t expect Dr Lowe to go to bat for you on this issue. His predecessors didn’t and there’s no indication his successors will.
Australian voters should stop counting on the RBA to curb inflation -- or expectations of it -- with the only weapon in its arsenal (a capacity for interest rate fiddling). Either voters must make it very clear to the government that it and its agencies alone should shoulder responsibility for inflation, or they have no alternative but to suffer in silence and suck up what’s going on.
