Another first Tuesday of the month, another 50-point interest rate hike from the Reserve Bank. It “will help bring inflation back to target and create a more sustainable balance of demand and supply in the Australian economy”, governor Philip Lowe says.
As has been noted over and over again, one of the big drivers of the current bout of inflation are external forces or those beyond the control of Australian policymakers — Vladimir Putin’s invasion of Ukraine causing global energy prices to spike, most particularly, but food prices have been affected by both the war and floods caused by the climate emergency.
The Reserve Bank’s response to that is basically “bad luck, we don’t care what’s causing inflation, we’re going to smash demand with rate rises” — with the goal of that being “more sustainable balance of demand and supply in the Australian economy”. The beatings will continue, in other words, until morale plunges to a low enough level that people are too scared to spend.
Then inflation will fall back to 2-3% and we’ll be able to once again have the Great Moderation that characterised most of the two decades before the pandemic.
But like many hopes of returning to the pre-pandemic world, what happens if that’s impossible?
The RBA’s thinking on the relationship between monetary policy and inflation is based on some core assumptions about policymakers and policy: that economies will continue to operate in relative stability, and that policymakers have the ability — if not always the will — to address structural problems that might drive up inflation. The occasional shock might disrupt markets — the financial crisis; a war; a major terrorist incident such as 9/11 — but economies will revert to stability. That was especially the case once the world became unipolar after the collapse of the Soviet Union. The US stood unchallenged geopolitically.
How much do those assumptions apply now? Russia has emerged as a malignant global actor and military and cyber threat. China is increasingly belligerent and confident in its ability to damage those who oppose its will. There’s already one major war going on in Ukraine; there are fears of a bigger one over Taiwan. Neither are particularly amenable to direct control by Western politicians.
Indeed, part of Western policymakers’ response to Russia, and to China in the event it invades Taiwan, is inflationary: sanctions.
Sanctions disrupt trade and investment and push up prices, which is why they horrify neoliberals who’d rather states didn’t go in for all that stuff about human rights and standing up to tyranny. They’ve certainly disrupted global energy markets, with the Putin regime blaming sanctions for what will be the permanent shut-off of Russian gas from Europe.
Trade and financial sanctions have grown steadily in importance in recent decades, particularly as US control of the world financial system has tightened, enabling the US to cut off the flow of money both to companies and countries. They are now a frontline weapon in international relations between major powers — far more so than in the 1990s, when sanctions were for tinpot regimes like Saddam Hussein’s.
Sanctions complement a growing reaction against globalisation (among consumers, and the companies they influence, and politicians too) and an increasing desire in Western countries for greater supply chain control. The pandemic has shown the disadvantages of long international supply chains. The result is increasing onshoring of manufacturing of certain items deemed “strategic” or “sovereign”. Much of this is crass protectionism and looking after industry mates dressed up in the language of supply chain resilience, but it’s real enough to push up prices as manufacturing moves away from the lowest cost centres in developing countries or developed countries with long-term expertise.
At least the inflationary impacts of sanctions and onshoring are within the control of policymakers, and fit the ’90s paradigm of policymaking. But three bigger threats are beyond the short- or even medium-term control of policymakers: climate change, pandemics and the growing shortage of workers.
All will be growing problems for the rest of our lives. Our worker shortage, created by lower-than-usual immigration and a lack of foreign students and holidaymakers as a result of the pandemic, is just a preview of what will happen for the rest of the century: workers will become fewer and ever more valuable around the world.
As major countries like China and the US age, the problem will become more acute. Sourcing immigrants will become a ferocious battle between developed countries trying to attract as many workers as possible (which is why Australia should be launching an emigration campaign in Europe this coming winter to lure well-educated, highly skilled Europeans to move to Australia where the weather is warm and the energy bills much lower).
Increasing impacts of disease will also play a role. Even among a vaccinated population, COVID continues to wreak havoc on workforces. At least policymakers will be better prepared for when, not if, the next pandemic arrives, but the timing and severity is a lottery, as is the capacity of vaccines to quickly deal with a new virus.
At least we have certainty about climate change: we’ve already failed to prevent significant and damaging climate change and continuing inaction will make a bad situation worse. Floods, droughts and extreme weather will become a much more common part of economic cycles, pushing food and energy prices up, disrupting core markets like insurance and pressuring budgets with greater infrastructure and recovery spending. The only upside is that the more rapidly we can decarbonise, the more rapidly we can abandon inherently energy sources that will be increasingly inflationary and volatile — coal and gas.
How does the RBA cope in a world where multiple external sources of inflation are beyond the immediate control of policymakers, where inflationary pressures are a constant, revolving mix of threats, not transitional phenomena? Does it persist with its 1990s “I have only one tool and it’s a hammer” approach of always bludgeoning demand? Does it keep playing what will increasingly look like whack-a-mole with interest rates? Or does it look for ways to adjust to the post-pandemic world?
The world has changed. The next 30 years will be a lot more difficult than the past 30. Even for central bankers.
