The RBA (Reserve Bank of Australia) Board doesn’t meet in January. That is a pity, because otherwise the Board might announce a New Year resolution. One particular resolution would be very reassuring to hear: A resolution to not raise interest rates until inflation expectations are re-anchored well above their pre-Covid levels. That is, not to waiver from the Bank’s current course, even as inflation goes to temporarily high levels in 2022.
There are other resolutions that the RBA might make. Its Board could resolve to not introduce any more extraordinary monetary programs, like the Term Funding Facility, unless the benefits clearly outweigh the costs.
Lending $188 billion to banks at an interest rate of only 0.10%, fixed for three years, was never a good plan. It was obvious that the TFF would both fuel the housing price boom and damage the central bank’s balance sheet once three year rates rose, with very little benefit in terms of extra lending to businesses.
Or instead, the RBA Board might resolve not to make commitments that it cannot keep, such as the RBA’s peg of the 3 year treasury bond yield to the cash rate. When the bond markets bullied the RBA into suddenly abandoning that peg in November of last year, the bank’s reputation was materially damaged.
The RBA Board has several compelling resolutions to choose from. But we all know that a single New Year resolution is challenging enough, so let it be holding the line on interest rates until inflation expectations re-anchor.
The RBA’s missteps in the Covid crisis will be soon forgotten if that single resolution holds. That is, if the RBA is not panicked by temporarily high inflation numbers, or bullied again by the bond market, into raising the cash rate prematurely.
It won’t be easy. In the Covid crisis, the Australian economy has received the greatest fiscal and monetary stimulus since WWII. So, inflation will inevitably print at high levels across the quarters of 2022, and even into 2023.
What lies beyond that spike of inflation is the crucial question facing the central bank of every developed economy.
Central banks take a long term perspective on these questions. They see the Covid19 crisis, and the accompanying stimulus, in the multi-decade context of powerful deflationary forces pushing down inflation around the world.
Global inflation has fallen since the early 1980s because the total demand for goods and services has lagged the growth in total supply. This demand growth deficit has resulted from a combination of factors, including: Ageing populations; technological progress; globalization and concentration of wealth.
The deficit of demand relative to supply has been filled through more and more debt of every type: Household, corporate, government and central bank debt (aka QE). In 1970 total global debt was 100% of global GDP. In 2022 that ratio will surpass 400%.
Deregulation and the growth of financial markets have facilitated the creation of all that debt. But eventually ever higher levels of debt will choke off economic growth itself, necessitating more and more debt.
Seen in the span of decades, the global economy since the early 1980s has been in a slowly evolving debt trap. Only growing debt has staved off a destructive downward spiral into outright deflation caused by a deficit of demand relative to supply.
It is easy to forget that immediately before Covid19 arrived Central banks were wrestling with deflationary forces and the slow motion train wreck of an evolving debt trap.
On 1 Oct 2019 the RBA cut the cash rate to the then record low of 0.75% — just three months before the first Covid19 fatality in Wuhan on 9 Jan 2020. At the same time the RBA was predicting a strong economy with real growth of 2.5% in 2020 and 2.75% in 2021.
Why did the RBA cut rates to a record low, even though it expected strong growth? Because long term inflation expectations were falling rapidly around the world.
Recall also that the US Fed recommenced QE in September 2019. That program was massively expanded in the Covid crisis, but it was begun without any knowledge or consideration of Covid19.
Central banks are fearful that after the sugar hit of covid stimulus, which has greatly increased total debt versus GDP, we return to the pre-covid world in which the fight against deflation is only sustained by more and more debt.
RBA Governor Philip Lowe has repeatedly stated his intention to avoid the debt trap by not raising the cash rate near zero until wage growth is sustainably within the 2-3% target range. These affirmations of the hurdle that must be met before the cash rate is raised are very welcome, but it would be helpful to have a stronger statement of what ‘sustainably’ means.
It will take a lot of resolve for the RBA to hold the line on not raising interest rates in 2022. But if that can be done until inflationary expectations are re-anchored at a higher point, then a crisis will not have been wasted.
Copyright 2022 Sam Wylie
This article was published in the Australian Financial Review on 9 January, 2022