Government’s Unexpected Legislative Success
When the prime minister addressed the media shortly after 8 am on Friday, the atmosphere was charged with elation.
The remarkable surge of legislation passed in the Senate on Thursday stood in stark contrast to the PM’s earlier struggles, where he had to pause the misinformation legislation along with unwanted reforms concerning the environment, gambling advertisements, and electoral donations.
Just a week ago, the government was facing a bleak and frustrated end to the year, hindered in delivering signature housing policies, uncertain about passing its Future Made in Australia manufacturing policy, and stymied in its attempts to limit international student numbers.
The successful navigation of 31 bills through the Senate on Thursday turned all that into a distant memory. Spin doctors were quick to declare that this was part of a clever plan weeks in the making.
However, the government could hardly believe its fortune regarding some of the legislation that had seemed long stalled but has now successfully passed in Parliament.
This includes amendments to the Reserve Bank Act, which will introduce a second board dedicated solely to setting interest rates.
We now find ourselves in a situation where the coveted independence of the RBA is such that the treasurer cannot even be seen to offer “helpful suggestions” regarding interest rates.
Whoever will be on the new board—set to be announced soon, but not functioning until at least March 1—will have to navigate the complex dynamics of this independence, which currently reflects a struggle over the economic outlook between the government and the central bank.
This interplay is undoubtedly more complex and significant than any multi-party negotiations that might occur in the Senate.
Should Interest Rates Be Heading Lower?
This isn’t merely a matter of the government desperately wishing for the RBA to lower rates ahead of the election.
Several of the nation’s largest financial institutions and leading economists have openly questioned central aspects of the RBA’s economic evaluation.
Even Treasury has taken a divergent approach to the bank, though subtly.
The crux of the issue lies in the state of the labor market.
Before diving deeper into the labor market, let’s explore some factors that might lead an observer to believe that interest rates should be moving lower.
The Reserve Bank, pragmatically, relies on two main factors for policy operation: the official interest rate it sets and its credibility. (AAP: Bianca De Marchi)
First and foremost, growth. The economy has experienced growth below “trend” for 18 months, and we have endured a “household recession” for the longest time in decades.
As of October, headline annual inflation was recorded at just 2.1% (and stable), while the trimmed mean, or underlying inflation rate, rose from 3.2% to 3.5%.
(It’s important to keep in mind that the RBA is striving to bring inflation back to between 2-3%.)
The Reserve Bank, practically speaking, has only two elements at its disposal: the actual official interest rate it sets and its credibility.
Changes to interest rates typically take time—between one to two years—to influence the economy.
This explains why official rates have previously been cut when the headline inflation rate exceeded 3% in four out of the five prior reductions.
So why has the bank been projecting a bearish stance, indicating it will not cut rates for several months?
The State of the Labour Market
This brings us back to the labour market and the NAIRU (the Non-Accelerating Inflation Rate of Unemployment), a theoretical measure of unemployment that keeps inflation and wage growth stable.
A high NAIRU figure suggests that conditions in the labor market will continue generating inflationary pressures, even in a context of high or rising unemployment.
The differing opinions regarding the economy’s shape hinge largely on the NAIRU. For those less familiar with economics, it centers on evaluations of the labor market’s strength.
Prominent figures in the economic conversation, including the Commonwealth Bank, ANZ, and labour market economist Jeff Borland, argue that the RBA has misjudged the NAIRU.
The RBA estimates the NAIRU to be at or above 4.5%, while Treasury estimates it at 4.25%, Jeff Borland at 4%, and the ANZ at 3.75%.
Gareth Aird, head of Australian economics at the CBA, recently commented that “the most recent wages data suggests the RBA’s NAIRU estimate might be too high”.
For the RBA’s wage forecast to materialize, “the quarterly speed of wage growth would need to jump to 1% per quarter in the final quarter of 2024”.
“Such an outcome seems unlikely, indicating that the RBA has probably overestimated the strength of wage growth within the economy.”
Overall, the data implies “the economy can sustain a lower unemployment rate consistent with keeping inflation within the RBA’s 2-3% target range”.
In contrast, when RBA Governor Michele Bullock spoke at a conference in Sydney on Thursday, she asserted that “currently, we believe labor market conditions are tighter than those that would maintain low and stable inflation”.
CBA noted “we continue to observe evidence suggesting that the disinflation process remains on track, economic growth remains subpar, and wage pressure is easing”.
The Difference in Assessments is Crucial
The Commonwealth Bank emphasizes that November’s RBA board minutes indicated “the importance of remaining forward-looking and not relying excessively on historical data that might lead the board to react too slowly to changing economic conditions”.
However, the CBA struggles to align this with the minutes’ indication that in a scenario where inflation diminished more rapidly, “this could justify an easing in the cash rate target, but they (i.e. members) would need to observe more than one favorable quarterly inflation result to feel confident that such a decline in inflation was sustainable”.
The CBA notes, “the policy-making process cannot be truly forward-looking if the board commits itself to awaiting more than one ‘good’ quarterly CPI result before considering the normalization of the cash rate. Inflation is inherently a lagging indicator, especially given the publication delays associated with the quarterly reporting.”.
The revered independence of the RBA is such that the treasurer cannot even be seen giving it a few “helpful suggestions” regarding interest rates. (ABC News: Matt Roberts.)
In the latest ANZ evaluation, head of Australian economics Adam Boynton comments that “at pivotal moments, we should emphasize what the RBA should be doing rather than its rhetoric”.
ANZ’s underlying assessment indicates that since the “NAIRU is likely around 3.75%, wage growth is expected to underperform the RBA’s projections”.
“Weakness in private demand and cooling in the housing sector also imply that current rates may indeed be restrictive.”
The divergence in assessments is critical for understanding the RBA’s perspective and the decisions to be made in the December and February meetings.
Compounding this situation is the fact that while Jim Chalmers cannot appear to meddle in the bank’s deliberations, the bank has historically been cautious about making interest rate decisions close to an election.
Ultimately, these decisions should be made free from political interference or anxiety over perceptions related to political judgments or how the bank may be evaluated by critics.
The ramifications of these decisions impact all of us and should always be weighed carefully, regardless of which board is responsible.
Laura Tingle is the chief political correspondent for 7.30.
