There was a time in a golden, sunlit past when we were sure that interest rates wouldn’t change for three years, and we could go about the business of borrowing money and bidding up house prices with a jaunty certainty.
It was an illusion, of course, cruelly dashed a year ago.
Now there’s anything but certainty. Two of the big four banks think there’ll be one more rate hike, two think not, the market says cuts are coming, not hikes, and the RBA is keeping its thoughts to itself.
That is, apart from some mysterious internal memos that discuss a cash rate of 4.8 per cent, absurdly extracted under Freedom of Information (FoI).
Last week, Bloomberg News scored a trove of memos from the RBA under FoI that revealed two main things:
Some modelling had been done with the cash rate at 4.8 per cent, and
the risk of recession in Australia right now is as much as 80 per cent.
The idea of the central bank having to cough up internal memos to a journalist is great for us, but utterly ridiculous.
The first of those nuggets was contained in a memo dated February 22, 2023, that proposed three possible scenarios for interest rates:
- First, a “steady climb” of 0.25 per cent hikes to 4.8 per cent by August 2023
- Second, “front loaded” hikes of 0.5 per cent each, getting to 4.8 per cent by May 2023, both of them to get inflation down fast
- Third, keeping the cash rate at 3.35 per cent till mid-2024.
Author unknown
We don’t know who wrote the email because the sender is redacted, and we don’t know who, if anyone, agreed with it, but naturally there were headlines about a possible 4.8 per cent cash rate.
The second key point – that the chance of recession might be 80 per cent – was in a memo dated September 2022, headed “notes to policy group”.
The sender was again redacted, but this time it was in the first person: “I assess the likelihood of a recession in Australia in the short term using two methods.
“Stochastic simulations using the MARTIN model and the August SMP forecasts suggest that there is a one in two chance of Australia end[ing] up on the ‘narrow path’ – where inflation returns to target without requiring a recession.
“In contrast, a probit model that incorporates longer-run historical data estimates recession risk to be much higher at 65 to 80 per cent.”
Who is this? Someone doing work experience, or the head economist Luci Ellis? And what, exactly, is the basis of the calculations?
The story also got a pretty big run in the media, but is that an accurate representation of RBA modelling about the odds of a recession?
It is quite ridiculous that internal RBA memos about the future of interest rates and the economy can be released under FoI without comment or context.
By the way, ‘stochastic’ means having a random probability distribution that can be analysed but not be predicted precisely, and ‘probit’ refers to deviation from the mean. The MARTIN model is the RBA’s all-singing, all-dancing model of the Australian economy, born in 2018.
Higher rate can’t be ruled out
There are two reasons a 4.8 per cent cash rate is not out of the question, and can’t be dismissed as the ravings of the RBA’s resident radical loony.
First, other countries with lower inflation rates than ours have cash rates above 5 per cent (New Zealand and the United States); and second, the RBA apparently regards the current cash rate of 3.85 per cent as neutral – neither tight, nor loose.
That means in order to bring inflation down it would need to be further tightened, a lot, which has some credibility because global inflation is proving to be sticky. By the way the budget has nothing to do with it – its impact on inflation will be a rounding error.
Then again, Australia has higher house prices and therefore higher household debt than most other countries, so there is a solid argument that the cash-rate trigger for a recession in Australia is lower.
The other important unanswered question is: What is meant by recession?
With net overseas migration this year of 400,000, the normal definition of two consecutive quarters of contracting GDP is useless, since that many extra people should hold national output aloft, no matter what else happens.
A better measurement would be per capita, and on that score, Treasury is predicting a per capita recession, since it’s forecasting 2 per cent population growth and national output growth of just 1.5 per cent.
A per capita recession is one that ‘feels like’ a recession, even though the ABS hasn’t announced it, and we do seem definitely to be headed for one of those.
That’s Sahm recession
Meanwhile, the internal RBA memos released under FoI introduce us to the term ‘Sahm Rule’ and ‘Sahm recession’ (named after Claudia Sahm, an American economist) which decrees that it’s a recession when unemployment rises by 0.75 percentage points above its minimum over the past 12 months.
According to one of the anonymous RBA memo writers: “This has the benefit of capturing periods where unemployment was rising and GDP growth was low, but not persistently negative.”
Another of the anonymous RBA memo writers says that while the “steady climb” and “front-loaded” paths for raising the cash rates are the quickest to return inflation to the target band in late 2024, they also push up the unemployment rate to 4.5 per cent, “narrowly avoiding a Sahm recession”.
Avoiding? That looks like a 1 per cent increase in unemployment to me, which Ms Sahm would call a recession, and so would I.
Anyway, the bottom line of all this is that the RBA needs to either find a way to keep its internal memos private, and away from journalists wielding FoI requests, or explain and contextualise them if it can’t.
Alan Kohler is founder of Eureka Report and finance presenter on ABC news. He writes twice a week for The New Daily
