Interest rate hikes will hurt workers to protect profits (Part 2)
This article continues from part 1 in the previous issue of ERAR. By September 6, the Reserve Bank of Australia had hiked its interest rate five times for the year, for a combined total of 2.35 percentage points. And it has signalled that further increases are ahead, as it joins other central banks around the world in rapidly increasing rates to slow spending power, job creation, and hence inflation. In this commentary, Centre for Future Work Associate Dr Anis Chowdhury challenges the wisdom of pursuing this strategy. Since current inflation is related more to supply chain disruptions and other global pressures, the higher interest rates will do more harm than good -and shift national income even further toward the owners of capital, instead of working Australians.
The interest rate: a blunt tool
The dogmatic stance of central bankers will cause more damage than it avoids. Even when inflation is rising, higher interest rates are not the right policy tool to tackle the problem for several reasons.
First, the interest rate only addresses symptoms, not the root causes, of inflation. Inflation is often understood as the overheating of an economy. Like a fever, overheating of an economy can be attributed to many causes – fever and overheating are just symptoms.
Interest rates, like the drugs Panadol and Aspirin, may relieve the overheating, but the treatment requires investigating the root causes and applying appropriate medications.
Second, interest rate changes affect all sectors – without distinguishing the sectors that need expansion, and hence credit support, from sectors that are less productive or inefficient and hence should be credit-constrained.
Just as taking too many Panadols or Aspirins can have fatal side effects, hiking interest rates too often and too high can kill productive and efficient businesses along with less productive and inefficient ones.
Third, the overall interest rate does not distinguish between households and businesses. Higher interest rates may encourage households to save, but will dampen the capital spending of businesses. Thus, overall economy-wide demand will shrink, discouraging investment in new technology, plant and equipment as well as skill-upgrading. Thus, higher interest rates will adversely affect the long-term productive capacity of an economy.
Fourth, higher interest rates will raise the debt burden for governments, businesses and households. Global debt burdens have been on the rise since the 2008-2009 global financial crises, and even more dramatically during the COVID crisis. Those debts (especially the sovereign government debts) are manageable for as long as economic growth remains robust and interest rates remain low. Current monetary policy, however, will negatively affect both factors: raising rates and slowing growth. That could set the stage for debt problems down the road.
Monetary tightening will have implications for fiscal policy, too. A slower economy implies lower tax payments and greater social security payments. Government is already under pressure to continue pandemic support measures, such as financial assistance for workers without paid sick leave as well as cost-of-living supports. Planned Stage Three tax cuts, if they go ahead, will further undermine Commonwealth government spending. For state governments, heavily reliant on revenue from stamp duties, a collapse of the housing market would devastate their budget bottom-lines.
Paradoxically, higher interest rates can even feed into higher costs of living, as indebted households’ debt-servicing costs (especially on mortgages) rise. The cost of living would also rise if businesses with market power pass on their own higher interest costs to consumers through still higher prices
As mentioned earlier, the current inflationary surge is due to supply shortages of key products, such as food and fuel. Therefore, the longer-term solution requires expansion of supply and removal of bottlenecks. Perversely, however, higher interest rates force overall demand to shrink in order to match aggregate supply. That effect can slow price increases, but leaves underlying supply constraints for key products unaddressed – hence not addressing the underlying causes of inflation.
Therefore, policymakers are advised to consider innovative and more appropriate policy tools in respond to the current price pressures. The focus of their anti-inflationary policy should be changed radically from suppressing domestic demand to enhancing supply and productivity; from restricting credit indiscriminately to easing financing constraints for key and ‘sun-rise’ industries (e.g., renewable energy) while tightening financial conditions for inefficient (e.g., polluting) and speculative activities (e.g., real estate).
This would mean designing macroeconomic policies to support industrialisation and economic diversification.
Rather than reacting to inflationary symptoms with a lone blunt policy tool (interest rates), policymakers should wield a mix of fiscal and monetary policy levers: using them to unlock
supply bottlenecks, enhance productivity, and also encourage savings and productive investments (especially to decarbonise the economy).
Each of these goals needs innovative and customised policy tools, rather than a one-size-fits-all reliance on interest rates to throw cold water over the entire economy.
Inflation and responses to it inevitably involve social conflicts over economic distribution. The ‘social dialogue’ approach of Australian Prime Minister Bob Hawke contrasted with the more confrontational approaches of UK Prime Minister Margaret Thatcher and US President Ronald Reagan – and their deliberate use of punishing interest rates to inflict long recessions during the 1980s.
In contrast, social dialogue in Australia not only brought down inflation and unemployment simultaneously in the 1980s, but also enabled some difficult reforms – including floating exchange rates and lower import tariffs. That set
the stage for sustained economic development in years to come.
The new federal Government needs to earnestly begin rebuilding that model of social partnership to confront not only current inflation challenges, but the more existential threats of climate change and shifts in the global order.
The government must also not miss the opportunity to review the RBA’s mandate and operations, including better balancing its board with a more representative variety of stakeholders (including workers). The Australian economy does not operate within a vacuum, and should not be entrusted to technocrats. Policies and reforms affect real lives and livelihoods. The RBA needs to understand, and hear, the voices and preferences of every Australian, not just financiers and employers.
A.I. Centre for Future Work, 4 Aug 2022