Federal Reserve actions seem to have important effects on the macroeconomy, but precisely why is one of the most poorly understood and contentious issues in economics.
(Ben Bernanke, 1988)
Following a concerted campaign by bank economists and their media cheer squad, the Reserve Bank of Australia (RBA) has raised the rate of usury yet again – the traditional Melbourne Cup Day jacking, so if you didn’t blow all your cash on the horses or booze, the banks will take whatever is left. Of course, they “also increased the interest rate paid on Exchange Settlement balances” (Bullock, 2023b), so not only do the banks get to take more of your money, they get more free money from the government as well. And what are the banks doing with all this money? Taking record profits and buying back their own shares (King, 2023). The question is why. Why is the RBA forcing all Australians to give more money to the banks?
The statements from the RBA are not so much an explanation, as a piece of symbolic liturgy. Parsed by the financial clergy for signs of intent, they also have a stated intent: to manage inflation by setting expectations of inflation. Attempting a divination of these meanings will take place in two parts. First, we will take the statement at face value, and compare that with facts on the ground – observable and measurable impacts of the increased interest rates. Then, in part two, we will analyse the statement as myth. Mythology draws from myth, reconstitutes myth, and has intent, in exactly the same way as design; so in this context we will also examine the design of MARTIN – the RBA macroeconomic model of Australia. From here, we will divine an intent that is consistent with both myth and MARTIN.
New RBA Governor Michele Bullock (2023b), in her second statement as governor, had some rather vague justifications for raising interest rates. These were nonetheless lapped up and reinterpreted for broadcast by the financial media:
Services price inflation has been surprisingly persistent overseas and the same could occur in Australia.
Services price inflation is surprisingly persistent overseas – so, what have interest rates here got to do with overseas service prices? Nothing! But, the same could occur in Australia. So, has it? According to the Australian Bureau of Statistics (ABS) All groups, services component, it has not. In the year-on-year figures, it has peaked and is heading down. In the quarterly figures it is further into a downward trend, and even allowing for the little spasm upward in the September quarter, it remains well below All groups, goods component, and the CPI, at an annualised rate of 4% - well below the peak of 8.4% in December 2022. It’s important to note here that the RBA, bank economists, and the media cheer squad all tend to focus on either the quarterly or year-on-year figure – whichever supports their story. In this case, the year-on-year figure seems the most persistent. Also important to note is that the year-on-year figures are backwards looking, and they are not yet looking backwards to the peak of services price inflation. That won’t happen until the December quarter, when of course a large downward shift will occur in the year-on-year number, and we shall all thank the benevolence of the RBA for sparing us an xmas rate rise.
There are uncertainties regarding the lags in the effect of monetary policy and how firms’ pricing decisions and wages will respond to the slower growth in the economy at a time when the labour market remains tight.
One certainty can be found in this sentence: the RBA demonstrates correct usage of the apostrophe. The uncertainties here are related to the fact that there is no coherent theory on how or when interest rates affect firms’ pricing decisions. As with anything in economics there are always uncertainties, but even a stiff dose of ceteris paribus cannot save this explanation of “The Transmission of Monetary Policy to the Economy” from the RBA (2023):
Interest rates affect economic activity via a number of mechanisms. They can affect saving and spending behaviour of firms and households, as well as cash flow, the supply of credit, asset prices and the exchange rate, all of which affect the level of aggregate demand. In turn, developments in aggregate demand, in conjunction with developments in aggregate supply, influence the level of inflation in the economy. Inflation is also influenced by the effect that changes in interest rates have on imported goods prices, via the exchange rate, and through their effect on inflation expectations more generally in the economy.
We can paraphrase that explanation into a more concise form without reducing the clarity of meaning: Interest rates affect this, this, this, this, this, this, this, and this, all of which affect that. In turn, developments in that, in conjunction with more or less of that, influence inflation, which is also influenced by that, via this, and expectations more generally. Clear? Little wonder the RBA has some uncertainty, if that is their best shot at explaining how interest rate changes are supposed to work.
The Governor’s Statement (Bullock, 2023b) goes on:
The outlook for household consumption also remains uncertain, with many households experiencing a painful squeeze on their finances, while some are benefiting from rising housing prices, substantial savings buffers and higher interest income.
We can be quite certain that “households experiencing a painful squeeze on their finances” are not now driving any inflationary growth in consumption spending, since they can barely afford vegetables. In fact, in the quarterly ABS figures, Food and non-alcoholic beverages inflation sits at an annualised 2.4%, exactly where the RBA would like it. As for vegetables, they are now in deflation, at an annualised rate of minus 22.4%, or minus 10.2% in the year-on-year figures. That’s because there were floods last year, and they might go up again if there is a drought next year. Either way, raising interest rates on these households will make absolutely no difference whatsoever to the price of vegetables or any other food, unless things get so bad that discounted cakes and biscuits deflate the whole category. Therefore, if the RBA has any concerns about excessive consumption spending, it must be those households with “substantial savings buffers” spending their “higher interest income”.
I ask you, dear reader, what do you think will occur to these households’ higher interest income if interest rates are raised further? You do not need to be an economist to answer that question, yet it seems the entire economics “profession” is incapable of even asking it. I say “profession” because economics has no code of ethics, so therefore technically is not a profession, and it is this absence of ethics that allows the RBA Governor to righteously declare that unemployment must rise to 4.5% to tame inflation, at which point that higher unemployment is redefined as “full employment” (Bullock, 2023a). That means 140,000 Australians must lose their job, and possibly their career, home and family, by the deliberate policy of raising interest rates until that happens. And yet the RBA is uncertain when, or even how, that will happen! The RBA’s justification for increasing interest rates is so contradictory it beggars belief. With no coherent theory of interest and inflation to underpin their decisions, all their mathematical formulae add up to nothing more than the performative symbolic posturing of expectations management, perfectly encapsulated in the regular Governor’s statement.
That’s about as far as we can go with face value and facts on the ground, without subjecting you to a deep-dive into the ABS figures. I did, so I will leave you with one last fact, along with my first and last reference to sticky prices. Deep within the breakdown of the quarterly inflation numbers by sector and product, we discover the last great sprinter of the inflation race. As all other goods and services fall away back towards normality, one product remains stuck near it’s September 2022 peak. With annualised quarterly and year-on-year inflation of 16% (ABS, 2023), the winner is...
.
Cheese.
Reference List
ABS. (2023, October 25). Consumer Price Index, Australia, September Quarter 2023 | Australian Bureau of Statistics. https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release
Bernanke, B. (1988). Monetary Policy Transmission: Through Money or Credit? https://fraser.stlouisfed.org/title/business-review-federal-reserve-bank-philadelphia-5580/november-december-1988-557643/monetary-policy-transmission-523684
Bullock, M. (2023a, June 20). Achieving Full Employment | Speeches (Australia). Reserve Bank of Australia. https://www.rba.gov.au/speeches/2023/sp-dg-2023-06-20.html
Bullock, M. (2023b, November 7). Statement by Michele Bullock, Governor: Monetary Policy Decision | Reserve Bank of Australia (Australia). Reserve Bank of Australia. https://www.rba.gov.au/media-releases/2023/mr-23-30.html
King, P. (2023, November 6). Latest presentations and results—Full Year 2023. Westpac Investor Centre. https://www.westpac.com.au/about-westpac/investor-centre/events-and-presentations/presentations-agm/
RBA. (2023, November 8). About Monetary Policy (Australia). Reserve Bank of Australia. https://www.rba.gov.au/monetary-policy/about.html