Reserve Bank of Australia rate hikes increase recession risk

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Connect the dots and you realize that the RBA’s plan to quickly reduce inflation involves allowing billions to be transferred from household pockets to big business profits.

On the one hand, large companies have been allowed to increase their prices more than necessary to cover their rising costs resulting from supply disruptions from the pandemic and the war in Ukraine. On the other hand, the unions’ loss of bargaining power means that large companies have had no trouble getting their payrolls to grow at a rate far below that of retail prices.

So households are paying the price for the RBA’s solution to the inflation problem. They will pay for it with higher mortgage interest rates and rents and a drop in the value of their homes, but mostly by raising their wages far less than the increase in their cost of living.

More than half of companies say they pass on increased costs to consumers.Credit:Sean Davey

The RBA’s unspoken game plan is to squeeze households until demand for goods and services weakens to the point that big business decides that raising prices to boost profits would cost them so much in sales that ‘they would be worse off.

It may even be that households are in such a hurry that the sales of large companies begin to fall, and that some of them decide that reducing their price to regain sales would improve them.

In economist notation, maximizing profits – or minimizing losses – is about finding the best combination of “p” (price) and “q” (quantity demanded).

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Don’t you think the big companies have ever lowered their prices? It is common for them to “cut” their prices in a way to disguise their retirement, using special offers, arranging sales and allowing a gap between their advertised price and the price many customers actually pay.

But why should this kind son of a mother, Dr Philip Lowe, whose legal duty it is to ensure that monetary policy is directed to ‘the greatest benefit of the Australian people’, impose so much suffering on so many ordinary people? , who played no part in causing the problem he is facing?

Because, like all central bankers, he sees keeping inflation going as his primary responsibility. And he sees no other way to prevent prices from rising so rapidly. It’s a case study of what crude, inadequate and brutal monetary policy is.

Lowe justifies his measures to quickly reduce inflation by saying that it will avoid a recession. But let’s face it. This massive transfer of household income to corporate profits will deal a severe blow to the economy.

After being nowhere for nearly a decade, real household disposable income is now expected to decline for two consecutive years. And who knows if there will be a third.

Economists have made much of the additional household savings during the pandemic. But during Lowe’s appearance before the House Economics Committee on Friday, it was revealed that around 80% of those $270 billion in additional savings came from the top 40% of households. . So how much of that ends up being spent is open to question.

The probability that our measures to weaken household spending will lead to a recession must be very high.

Until Lowe’s remarks before the committee on Friday, his commentary on the causes and treatment of inflation seemed terribly one-sided. The key to reducing inflation was to ensure that wages did not rise as much as prices, so that rising inflation expectations did not lead to a wage-price spiral.

He warned that the more wages rose, the more he would have to raise interest rates. He lectured the unions, saying they needed to be “flexible” in their wage demands. You might think of it as giving an official blessing to companies that resist union pressure and hand out wage increases well below the price hike.

After being nowhere for nearly a decade, real household disposable income is now expected to decline for two consecutive years. And who knows if there will be a third.

Lowe could just as well have lectured companies to be “flexible” by passing on all the higher costs of their imported inputs, when these were supposed to be temporary – but he didn’t. He always quotes what business people tell him, but never what labor leaders say – perhaps because he never talks to them.

But on Friday, he tied the record. “It’s also important to note that to date, stronger wage growth has not been a major driver of higher inflation,” he said. “Companies also have a role to play in avoiding these adverse outcomes, by not using rising inflation as a hedge for increased profit margins.”

It is the very first time that he admits that, when conditions allow it, companies have the market power to raise their prices more than by raising their costs. The problem is that the only monetary policy solution to this structural weakness – caused by inadequate competitive pressure – is to keep demand perpetually weak.

Ross Gittins is the economics editor.

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