The Reserve Bank of Australia should take a Christmas break
A further rise in spot rates in December would push mortgage payments to their highest level on record as a proportion of household income. Although many households have enough funds in offset accounts to meet the higher mortgage payments, they will inevitably cut back on spending elsewhere, cooling the economy.
The latest wage data confirms that real wages continue to decline. Where is the proof of the dreaded wage-price spiral?
In search of a price-wage spiral
When asked what he would like for his birthday, a comedian from the 1980s replied: “Nuclear war – in order to eliminate the threat of it.” Sometimes one gets the impression that doctrinaire monetarists are hoping for evidence of a wage and price spiral in order to eliminate the threat of it by plunging the economy into recession.
Although the Reserve Bank’s board has been on the lookout for a wage-price spiral, it has yet to find one. Still, the prospect of spiraling wages and prices prompts the board in its November statement to consider possible additional monthly increases in spot rates of up to 0.5 percentage points.
But what if the economic diagnosis is wrong?
Like the threat of nuclear war of the early 1980s, the price-wage spiral of the early 1980s was a product of conditions prevailing at the time. They included two massive oil shocks, centralized wage setting and a unionization rate of around 50%, compared to less than 15% today.
Having failed to anticipate the post-pandemic inflationary surge, central banks around the world are now extremely confident that they are right in their savage monetary tightening to prevent a wage-price spiral.
Do world central bankers ever engage in self-reflection?
What if, just as their immediate post-pandemic policy fails, these central bankers misdiagnose the current inflationary crisis?
Rather than experiencing a wage-price spiral of the 1980s, Gerwin Bell suggested that the world could experience an inflationary episode closer to that of the immediate post-war period.
World War II unquestionably disrupted supply chains and created labor shortages as workers became soldiers and fought in armies. And to put it mildly, fiscal and monetary policy was in overly expansionary mode.
At the end of the war, inflation jumped, but the authorities did not react by tightening fiscal and monetary policy to prevent the emergence of a wage-price spiral.
Instead, supply chains were repaired, soldiers went home to work, and inflation fell quickly without the need for harsh monetary tightening.
Do world central bankers ever engage in self-reflection? What if they misdiagnose the current inflationary struggle?
The preponderance of central bankers around the world survived the 1970s and 1980s, but none of the 1940s. They relied on economics textbooks covering the experiences of the 1970s and 1980s and much less on economic history books .
It’s no surprise, then, that groupthink plagues the central banking class of the 2020s.
Here in Australia, the Reserve Bank at least is open to the possibility that a wage-price spiral does not occur.
Nothing would be lost if the Reserve Bank’s board paused at its December meeting and reviewed economic data again to inform its decision on the cash rate at its February meeting.
There is a desirable humility in a central bank that recognizes that its staff and economic models cannot confidently predict the future. Lately, the tone of the Reserve Bank’s statements reflects such humility. Hopefully Governor Lowe’s speech at the CEDA dinner will continue this refreshing approach.