Raising Interest Rates Won’t Stop Inflation

The Reserve Bank of Australia has raised interest rates again, ostensibly to keep inflation in check. But the reality is that the move will only enrich banks and rich property investors — at the expense of renters and struggling mortgage holders.

Signage at the Reserve Bank of Australia (RBA) building in Sydney, Australia, on February 6, 2023. (Brent Lewin / Bloomberg via Getty Images)

On Tuesday, the Reserve Bank of Australia (RBA) raised interest rates for the twelfth time in fourteen months. RBA governor Philip Lowe justified the rate rises as an attempt to reduce inflation from the current 6.8 percent to his preferred range of 2 to 3 percent. Lowe, whose term as governor ends in September, heavily implied that this unprecedented run of rate rises will continue throughout 2023.

The rate rise will overwhelmingly hurt ordinary Australians. Mortgage holders — the majority of whose loans are on variable rates — will suffer directly. Renters will also suffer as landlords pass on the increase to them, exacerbating the cost-of-living crisis and putting homeownership even further beyond reach.

The latest rate rise comes just days after university loans automatically increased by 7.1 percent. Despite the fact that nominal wage growth is only 3.7 percent — dramatically below inflation — Lowe insisted that “we have to make sure that higher inflation doesn’t translate into higher wages for everybody.”

Perhaps the only positive aspect of the current debate over inflation is that there is a debate at all. Despite the best efforts of big business and the financial press, questions are quietly emerging about exactly who is to blame for rising prices, who should be disciplined to contain them, and how.

“For Some Households”

Lowe admitted that raising interest rates hurts working people. “The use of this tool comes with complications,” he conceded, noting that

Its effects are felt unevenly across the community, with rising interest rates causing significant financial pressure for some households. But this unevenness is not a reason to avoid using the tool that we have.

By Lowe’s phrasing, “financial pressure” sounds almost incidental. In fact this is precisely the point of the tool. The idea is that high costs will scare borrowers, who will limit their spending. Unemployment will increase; by the RBA’s own estimates one hundred thousand people will be thrown out of work. This will reduce employees’ bargaining power and put a downward pressure on wages.

And most crucially — although it’s almost always left unsaid — all of this is then supposed to persuade businesses to stop choosing to raise prices so quickly.

If punishing workers in order to gently make a suggestion to employers seems a harsh way of getting something done, you couldn’t tell from the business response. The financial press used Lowe’s announcement to further attack a recent decision by the Fair Work Commission to raise award rates by 5.75 percent, even though in real terms, this is a wage cut.

A Wage-Price Spiral by Any Other Name . . .

Peak employer bodies have in part blamed supply-chain issues like the war in Ukraine and COVID-19 for rising costs and prices. What they usually fail to mention, however, is that they have already recouped many of the costs associated with these problems from the taxpayer through various federally funded subsidies.

This isn’t the only way that employers have manipulated the narrative to maximize profitability. Business groups also maintain that lifting minimum and award wages forces them “to make decisions around passing these costs on, so in the end it ends up with consumers who will pay the bill.” In other words, they claim that higher wages lead to higher prices, leading to a “wage-price spiral.”

This is deliberately misleading. Most Australian workers have experienced real wage cuts because they haven’t been pushing for — or receiving — wage rises even close to inflation. Business groups just imply that workers could demand wage increases in line with inflation, claiming that this possibility underpins employers’ choice to raise prices. Unable to point to any actual wage-price spiral, they have invented a hypothetical one. They also blame rising unit-labor costs as a culprit driving inflation. This refers to productivity, a loaded term implying that employees must continuously work harder than previously for the same wages. If they don’t, businesses insist that they are forced to raise prices to avoid any squeeze on profit margins.

However, businesses’ “our hands are tied” account has not gone totally unchallenged. While still limited in reach, rival explanations for inflation have appeared that propose different, less austerity-driven cures. Like similar debates elsewhere, the emergence of alternative, more egalitarian narratives has stirred up a hornet’s nest of orthodox economists.

For example, the OECD world economic outlook — published the same day as Lowe’s speech — suggested that the oligopolistic nature of the Australian economy is driving inflation. If a few big companies dominate the market, they can raise prices however much and whenever they like. As the former chair of the Australian Competition and Consumer Commission (ACCC) put it, “nothing that they’re doing breaks the law; there’s no law against excessive pricing.”

In other words, inflation is caused by corporate price gouging. This explanation isn’t just more accurate — it also fits with ordinary Australians’ experience of Woolworths and Coles raising grocery prices arbitrarily, or the big four banks refusing to pass on rate rises to deposit products.

The Australia Institute’s Centre for Future Work has suggested a complementary explanation that’s even more incendiary, arguing that profits are the major cause of the current inflation. In the Centre for Future Work’s account, we’re not in a wage-price spiral, but a profit-price spiral. It’s the result of Australian companies raising prices across the board as they seek — and post — record profits, far beyond any increase in costs they’ve experienced.

The Narrow Road of Political Feasibility

Confronted with claims that an oligopolistic economy and a profit-price spiral are to blame, orthodox economists have responded tellingly. While acknowledging that oligopolies make inflation more likely, the RBA and business lobby have categorically rejected the notion that profiteering is a cause of inflation. Some at the RBA criticized the Centre for Future Work’s methodology. Other economists simply dismissed the question as silly.

For example, according to Richard Holden, a University of New South Wales economics professor, “it doesn’t really matter where the price increases are coming from. Monetary policy has still got to go on.” “A doctor doesn’t care where you got a disease,” agreed Peter Tulip, a former senior RBA researcher. “The medicine prescription is going to be the same anyway.”

It appears that to the prescription-happy Dr Tulip, it’s irrelevant whether or not we’ve got the disease at all — all that matters is that we take his medicine. Business and governments have been prescribing the same thing regardless of what’s happening in the economy. When inflation hovered below 2 percent for the second half of the 2010s, they admonished Australian workers that wage growth was irresponsible, and urged productivity increases. Now we’re facing high inflation, and the advice is identical. There is no suggestion to business that excessive price hikes are irresponsible, or that these need to be accompanied by some action or other that benefits the wider economy.

In fact there are many possible “prescriptions” that the authorities could consider. Windfall taxes, oligopoly-power reduction, price controls, and direct government investment could all potentially be used to help drive down inflation. None of these suggestions are revolutionary in the slightest.

The common refrain asserts that these measures are not politically tenable. But to whom? When the government imposed price caps and expanded direct public investment in the energy sector to control inflation, businesses’ grumbling acceptance was telling. It demonstrated that business will only tolerate government intervention if it can clearly see the longer-term benefits for itself — and barely even then.

For now, the RBA and the treasury have correctly wagered that it is more politically feasible to hurt workers than employers. In part, this is because workers are largely unorganized. And even if they were, every industrial tool workers have at their disposal to tilt the situation in their favor — like striking — is functionally illegal. Employers, by contrast, face few equivalent political or economic constraints; they have carte blanche to retaliate against governments they are unhappy with. And they will continue to use this freedom to transfer Australian wealth upward.