Economics Analysis

Reserve Bank playing with fire — beware of the creeping recession

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(Cartoon by Mark David / @MDavidCartoons)

The RBA is risking repeating the errors that led to the deep and dark recession of the early 1990s. Stephen Koukoulas reports.

A FEW OF US old-timers remember the factors behind the lead into the early 1990s recession. Most fundamentally, it was how the unfolding dire economic news crept up on a misguided Treasury and Reserve Bank of Australia (RBA), which meant that monetary policy was kept too tight for too long. This plunged the economy into its deepest economic downturn since the 1930s Great Depression.

Back then, I was working in the now defunct Monetary Policy Section of the Treasury as a relatively junior operative and got to see – proofreading and number checking mainly – the material that the Treasury Secretary would take to each RBA board meeting and the RBA papers that would form the basis of its deliberations.

Many issues stick in my mind at that time, around 1989, when official interest rates had been snugged higher to around 17 or 18 per cent as monetary policy was used to crunch the economy, to reduce demand for imports, so that the current account deficit would be lowered. 

One particular issue I recall that is relevant to today’s circumstances was how the Treasury and the RBA steadfastly relied on hard data to set monetary policy. In doing so, they all but ignored the howls of economic hardship and pain that were coming from the heavily indebted business sector, firstly, and then from the household sector as the economy started its nosedive.

With strong overtones of arrogance, the Treasury in particular and the RBA knew better than to listen to the business world in 1989 who, the policymakers thought, were overstating how tough economic conditions were and as a result were only trying to pump up their business interests calling for interest rate relief.

This turned out to be a serious policy error.

By all but ignoring the feedback from the business sector, the start of the interest rate-cutting cycle was delayed, which meant that the interest rate cuts were slow to materialise. This was even with a more pragmatic RBA Governor, Bernie Fraser, trying to convince the Treasury that the economy was in poor shape and that a series of interest rate cuts were needed.

This policy misstep saw the unemployment rate hit a staggering 11 per cent. Hundreds of thousands of lives were savaged by lack of work. From a macroeconomic perspective, there were many years of substandard economic growth, which led to a huge amount of slack in the labour market.

Fast forward to today

For the last 18 months or so, the heavily indebted household sector has been smashed by very high interest rates — too high for too long. Businesses are hurting, too, but consumers are under the most pressure.

Consumer sentiment – and with that, household spending – has never been weaker. There is no evidence that these worrying trends are anywhere near a turning point higher. This is even with wage growth rising and the unemployment rate still relatively low.

Business confidence and conditions, which had been resilient through to the middle of 2023, are now tracking lower. These trends are signalling more troubling times for the economy. If, or rather when, these moves to pessimism spill over to a pullback in business investment and hiring, the economy will remain weak into 2025 and unemployment will rise, probably sharply. Indeed, the index of business conditions is now below the long-run average and showing no signs of bottoming out.

In simple terms, businesses are joining consumers screaming that economic conditions are tough and getting worse.

What happened 35 years ago is being repeated

Despite this unambiguously pessimistic economic news in recent months and quite miserable levels of consumer sentiment and faltering business confidence, the RBA is steadfastly unwilling to ease monetary policy from the current restrictive stance. Indeed, the RBA, quite astonishingly, is not ruling out the possibility of further interest rate increases.

Most recently, the RBA has noted:

  • ‘... the data indicate continuing excess demand in the economy, coupled with strong domestic cost pressures...’; and
  • ‘... conditions in the labour market have eased over the past year, but remain tighter than is consistent with sustained full employment and inflation at target. Wages growth appears to have peaked but is still above the level that can be sustained given trend productivity growth.’

While this interpretation is problematic when parlayed against hard data on domestic demand and the labour market, particularly with the various labour demand indicators – job advertisements and vacancies – falling sharply, it gives no status to the dire feedback from consumers and businesses.

If there is anything like a close re-run of the economic trends of 25 years ago when the hard data on jobs and growth are released in the months ahead, it is likely to paint a glum picture of the economy.

If the RBA was alert to this fragile outlook, it would be embarking on a gentle and gradual easing on interest rate settings, with the final extent of the rate-cutting cycle to be determined by the flow of news. Interest rates have already been cut in the Eurozone, Canada, Sweden and Switzerland, with cuts widely expected in the UK, the U.S. and New Zealand in the next few months.

By ignoring feedback from consumers and businesses and failing to cut interest rates, the RBA is playing with fire and risking repeating the errors that led to the deep and dark recession of the early 1990s.

Stephen Koukoulas is an IA columnist and one of Australia’s leading economic visionaries, past Chief Economist of Citibank and Senior Economic Advisor to the Prime Minister.

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