Even though inflation has peaked – it fell to 6.7% last week – we are still being told to expect high interest rates to persist well into 2024, or beyond. This is despite the lack of evidence that household spending and wage growth justify the Reserve Bank’s determination to keep on clobbering low and middle income households with high interest rates as the best (and so far, only) remedy for the cost of living crisis.
This hammering away at household spending – and at employment – assumes that the main cost-of-living drivers are all lined up on the demand side of the economy. In fact, we know that in the wake of the pandemic, the supply side problems (blocked supply chains, the Ukraine war, surging freight and energy costs) have been just as important in fuelling inflation, or even more so.
Therefore, having the RB pulling the interest rate levers has done sweet nothing at all to address the causes of imported inflation. Similarly, the RB won’t be doing much to address the structural causes of domestic inflation, either. All its actions will do is crush household budgets, make many households go without essentials, force some people to default on their mortgages, and throw tens of thousands of people out of work – all in order to fix what even the RB concedes to be only a transient problem.
As Torrens University associate professor Steven Hail recently told Australian journalist Maeve McGregor: “There’s simply no empirical or historical evidence that manipulating interest rates is the most successful way to try to manage inflation — none.” Instead, Hall argues, a combination of fiscal policies and better competition laws that take a more aggressive approach to monopolists, would “be better suited to managing demand and inflationary pressure.”
Fat chance. Monopoly or duopoly price setters being left free to prey on captive markets? Hey, New Zealand is a world leader at that sort of thing. All along, our Reserve Bank’s narrow view of what causes inflation (and the therapeutic role it assumes interest rate hikes will play in reducing it) has assumed that a scary late 70s/early 80s “wage price spiral” has been imminent.
In reality though, the value of real wages has been falling for years, and the union movement has been atomised in ways that make a repeat of union mobilisation in support of 1970s style wage demands looks like a highly fanciful notion. Fair Pay Agreements are all well and good, but they’re a pale echo of what has been lost.
During and after the pandemic, our neo-liberal market economy has been given very little to fear from (a) the Reserve Bank’s tunnel vision and (b) from the government’s deep reluctance to tackle the monopoly or near monopoly concentrations of pricing power held by – for example – supermarkets and banks. Firms have largely been left free to hand their own input costs (and more!) on to consumers, because there is nothing to stop them charging whatever the market can bear.
When it comes to household essentials, the sky continues to be the limit.
By contrast… In Europe‘s central banking circles it is now accepted wisdom that “greedflation” (aka widening profit margins)has been a prime culprit in stoking up inflation, post pandemic. A month ago, European Central Bank President Christine Lagarde provided a useful policy tour of the recent post-Covid landscape. Lagarde warned against a “tit for tat dynamic” whereby the widening corporate margins served to force salaries and prices higher in reaction. Currently, this process looks more like a “price/price” spiral than an old school “wage/price” spiral.
In similar vein, Bloomberg News reported only last week:
So-called ‘greedflation’ is threatening to complicate efforts to rein in consumer-price growth, meaning the ECB may have to do more to hit its 2% target — just as officials flag that the end of their most aggressive cycle of interest-rate hikes is approaching.
“There are clear risks for the inflation decline to be slower than previously anticipated due to rising corporate margins,” said Piet Christiansen, chief strategist at Danske Bank in Copenhagen.
That’s because companies tend to raise prices more quickly to offset higher input costs than they cut them when their expenses fall, allowing them to run larger margins for longer, he said.
If anything, wages have merely been playing “catch-up” to cost of living increases being driven by excessive profit-taking:
Corporate profits have been a bigger driver of price gains than labour costs for some time — since the start of 2021, according to Bloomberg Economics’s Maeva Cousin. She calculates that swelling earnings generated more than two-thirds of inflation at the end of last year.
Central banks however, have been slow to realise how much of the inflation problem they face has been profit- driven. They’ve been even slower to act:
Already accused of acting too sluggishly as prices began their post-lockdown ascent, margin expansion only emerged as a clear concern at the ECB in recent months and only really came to the fore at March’s policy meeting.
“Many firms had been able to raise their profit margins in sectors faced with constrained supply and resurgent demand,” Chief Economist Philip Lane told his colleagues, arguing that “wages had had only a limited influence on inflation over the past two years and that the increase in profits had been significantly more dynamic.”
Point being, wages and household spending have been only the secondary drivers of the cost of living crisis. Regardless, they have suffered 100% of the punitive response from the RB and the Labour government, both of whom still seem to be still living with 40 year old perceptions of wage/price spirals and related remedies.
Footnote One: The fact the world’s recent spike in inflation is only temporary and will be self-correcting (by mid 2024 or thereabouts) should be telling the RB that the causes of this current cost of living crisis are different to what the world experienced 40 years ago. That crisis did have ingrained causes and expectations. This one hasn’t. That’s why relentlessly imposing the same early 1980s solutions is likely to do far more harm than good.
For that reason… Taking a pause to see how the rate increases taken to date are impacting firms, workers and households seems an entirely sensible approach. It’s what Australia’s central bank has done.
After all, the main impact of people coming off fixed term mortgages has yet to be felt. The RB shouldn’t be adding to their problems before it knows the full extent of the carnage it has already wrought.
Footnote Two: Because the RB acts “independently,” the government has largely sat on the sidelines and left the fight against inflation to it. This is supposed to be a good thing. Supposedly, it virtuously leaves the RB free to practice the tenets of neo-liberal economics free from any government interference. This is despite the fact that the ideology being pursued by this group of un-elected bureaucrats has such deep and lasting impacts on our day to day lives.
As the Aussie academic Steven Hall cited above reminds us, that’s also why when Margaret Thatcher was asked about what her greatest achievement had been, she replied: “Tony Blair.” Meaning: an extreme ideology has been normalised and put beyond democratic accountability, as if it is the natural order of things.