Reserve Bank Governor Philip Lowe is getting bad press, most of it undeserved.
His detractors – those who complained about continual increases in interest rates – seemed happy enough when he kept them low.
Lowe and his board are raising rates at nearly the fastest rate ever, for the same reason they’ve cut them to an all-time low – to try to get the economy back into some sort of balance. .
It’s hard. But it’s been done before and it worked.
In fact, the man who pushed rates down and then up even more aggressively than we see now, former RBA Governor Bernie Fraser, told me this week that he approved of the way Lowe was doing his job – with one exception.
How Lowe’s Low Rates Saved Jobs
When COVID hit in 2020, at a time when the Reserve Bank’s cash rate was already at an all-time high of 0.75%, the bank cut what Lowe described as the “effective lower boundby 0.25%, before falling back to 0.1%, and offering banks virtually free loans at 0.1%.
Lowe’s promise to buy as many government bonds as needed to bring the three-year bond rate down to 0.1% drove three-year fixed rate mortgages to less than 2%. Variable rate mortgages fell to 2.5%.
Along with the Morrison government, which has been spending heavily in response to COVID, Lowe cut rates to try to keep an economy that was shutting down alive.
The best measure of unemployment is one that considers Australians working zero hours as unemployed. He climbed to 15 percent in April 2020 – the worst since the Great Depression.
Stimulus programs, the arrival of vaccines and the end of lockdowns worked wonders, as did the determination of the Reserve Bank to ensure that almost anyone who wanted to borrow could borrow for next to nothing. Spending rebounded and by July this year unemployment had fallen to its lowest level in five decades, at 3.4%.
Then, this year, inflation – which had stayed close to the Reserve Bank’s 2-3% target for a record 30 years – broke free and soared; first at 5%, then at 6% and now at 7.3%, all in the space of a few months.
Despite earlier hopes (those who had hope in the United States and the United Kingdom, where it also happened, called each other “transitional team“) inflation has not come down and shows little sign of returning to 2-3% on its own.
Inflation of 7% matters because a price increase of 2-3% per year is very different from an increase of 5-7%. This makes inflation, in the words of former Governor Bernie Fraser, “a topic not discussed at barbecues.”
At 2-3%, people adopt a fairly stable price mental model where when they agree to provide a service at a certain price, they know what they are getting into.
It’s not so much that high inflation creates winners and losers; the problem is that it becomes almost impossible to tell who will be the winners and the losers. It’s the arbitrariness of who succeeds in planning price increases and who suffers, which makes businesses difficult to manage and expenses difficult to plan.
The clear instructions of the RBA
The Reserve Bank has a writing riding lessons of the treasurer to aim to obtain “an inflation between two and three percent, on average, over time”.
Pretty much the only tool he has to do this is the manipulation of interest rates.
It is certainly true that much of what triggered the last surge in inflation will not be dampened by high interest rates. Diesel and gasoline prices are set internationally and skyrocketed after Russia invaded Ukraine.
But much of what triggered and sustained the resurgence of inflation can most certainly be brought under control by high interest rates.
The rising cost of almost everything
Building houses is expensive due to an (international) shortage of building materials and a shortage of workers not reduced by COVID. True, more materials and healthier workers would lower prices, but so would lower demand for construction work. Higher interest rates help limit demand.
Even the world price of oil can be held down by high interest rates – not by high interest rates here, but by high rates in the United States, which is a nation big enough for consumers to squeeze belt to make the difference.
Either way, Australian inflation is now incredibly widespread, encompassing almost everything sold here, including most things made here.
The verdict of a former RBA governor
This week, I phoned the person who is arguably best qualified to assess the job Lowe is doing now as RBA governor — someone who was in his shoes three decades ago.
Bernie Fraser was Governor of the Reserve Bank between 1989 and 1996. He lowered the cash rate 15 times in three years to accelerate the recovery from the recession of the early 1990s. Then in 1994, at the first sign of recovery of inflation, it made them rise faster and more aggressively that Lowe has so far this year.
Fraser told me he wanted to “shock people – let them know you’re out there, you’re concerned about inflation and want to avoid it.”
Fraser stopped raising rates only when he brought inflation back to where it has been for most of the past three decades. In this case, it was able to do so without increasing unemployment too much.
Fraser said he approved of the way Lowe was doing his job – although he said Lowe was wrong to suggest during COVID that rates would stay low for three years. But he also noted that setting rates is more of an art than a science.
Fraser believes that in due course, shortages will ease and inflationary pressures will ease. In the meantime, it is essential to let people know that the bank will do what is necessary to bring inflation down, up to the point (but not necessarily including) rising unemployment.
Fraser thinks there’s a good chance that Lowe can bring inflation down to 2-3%. He should know – he’s done it before.
Peter Martin is a visiting scholar at the Crawford School of Public Policy at the Australian National University. This article originally appeared on The conversation.