Capital Rule: Interest Rates, Inflation and The RBA

I’ve been absent from my blog for a while. Sometimes your intentions don’t get realised and life gets in the way! I’ve decided to recommence posting as I learn more about macroeconomics and political economy (a lot of self study) and throw my thoughts out into the public. I find it infuriating that the media has economist spouting bullshit and it just seems to be taken as gospel. If any behavioural scientist out there can explain why orthodox economics hasn’t been delegated to the bin after covid (debt and deficit fears, inflation fear mongering etc..) please share your thoughts. Plus I am trapped in a hotel room with covid. The last few days I’ve been knocked out with sore joints and muscles, a sore chest, coughing, fevers, runny nose, headaches. It’s the worst I’ve ever felt from a virus. Nothing has been ‘mild’ (as some like to make out) and I am triple vaccinated – with my last jab some 5.5 months ago.

It’s not all bad. I took this lovely shot from my room of the sunset.

Anyway…. to our topic at hand!

There is a lot of who-ha on interest rates in the media. Economists that think they should go up (or they’ve gone up too fast/slow) endless talk of inflation, printing money, government spending being too much blah blah blah…. It is safe to toss anything paraded by an economist in the media into the bin with the understanding they are full of trash.

Let us take a deep breath and look at what these decisions mean and whether they will have the desired results. First we need to understand the interest rate discussed in the media is – and how we define inflation.

What is the Interest Rate?

The interest rate referred to is known as the cash rate – and the rate the RBA targets that banks loan to each other. That is the 0.85% figure. In the same way you have an account with a financial institute your financial institute has an account at the RBA. These accounts (known as exchange settlement accounts) need to be positive at the end of each day and account holders who are short need to borrow from account holders who have surplus reserves.

The RBA has started publishing the interest rate it pays on exchange settlement accounts. This is 10 basis points below the target rate. Banks with surplus reserves won’t loan below that rate (currently 0.75%) and they attract a higher interest rate 10basis points above the target to borrow from the penalty window (directly from the RBA) This has banks loaning to each other at around the RBA’s target.

What is Inflation and why is it here?

This is a complex question. There is lots of debate, though most of it not worth listening to, about what causes inflation. I detailed some of that in the mythology of printing money part II and you can see more about inflation here and here. Simply inflation is a rise in the general price level. That in itself is an abstract concept however it’s purpose is to try and eliminate price rises so economists can determine whether real output is growing.

Orthodox economist will usually come out with nonsense around the money supply growth and ‘printing money’ being inflationary. The first thing to acknowledge is that any spending can be inflationary irrespective of who is spending it. Second ‘printing money’ is nomenclature that doesn’t apply to any spending operation in our economies today. The term has its origins when governments started banning private note issuance on notes issued by private banks and started issuing their own treasury notes. You need only look at the hansards from The Australian parliament from 1910 and the introduction of the Australian Notes Act to see the nonsense paraded how it would end the economy and be destructive! Currency is a public monopoly issued by the state. It spends by marking up bank accounts. Once you’ve disabused notions of the nonsense of printing money we can look more seriously at what is causing prices to rise.

The ABS last released CPI results on 27/04/2022

  • Fuel prices caused by easing of covid restrictions and war in Ukraine
  • Rental markets reflecting historically low vacancy rates
  • Grocery products because of transport costs
  • Rising construction costs mostly because the removal of government construction grants that had the effect of reducing out of pocket expenses for consumers.

We can see quite clearly the price increases are a result of supply side issues, due to fires and floods we’ve had, the oil companies cartel behaviour and even the removal of government spending. When you hear politicians or economist say the government should’ve spent less that is simplistic. Government spending can be deflationary – you only need to see my post on the effect of childcare being made free to see what effect that had on the CPI.

Once you break the myth of deficits accumulating debt and it needing to be paid back by our currency issuing government here are some things that can decrease our cost of living.

  • Publicly owned renewable energy infrastructure with a free quota delivered to every household
  • Universal free childcare
  • Parental leave paid at minimum wage until youngest turns 5
  • Free public transport and investment in mass public transit systems
  • Legislated work from home rights
  • Social housing for the masses with buildings built to suit location and strict environmental standards.
  • Expansion of public services to include building local communities and paying people to work in things we currently volunteer for (e.g community gardens, surf life safety, arts etc..)
  • Free Universal Broadband
  • Public Bank to regulate credit markets

My above list reflective of my value system. Our currency issuing government always has the capacity to finance those services, it is a question of whether we have the labour skill and other resources in sufficient quantities to provide them.

What does the Interest Rate have to do with Inflation?

By now the layperson is usually grappling with why the Reserve Bank would be hiking rates to bring inflation down. The academic theories usually fall back to the higher cost of money meaning a slowing of spending which is the narrative perpetuated in the media. This is propaganda. An increase in the cash rate means;

1. Increased income for asset (bond) holders;
2. Rewards markets that have placed bets on rates rising;.
3. Increased mortgage costs (and reduction on discretionary spending for households) and increased bank profits;
4. Increased cost for business that have borrowed to fund their capital (likely to be passed on to consumers)

What the net outcomes of the distributional effects of raising the cash rate is inconclusive. But it is probable that businesses will pass on rising costs to consumers. Which is inflationary.

How we should think about Inflation

Inflation is a conflict between labour and capital. The labouring class has little power to negotiate higher wages because of neoliberal governments that have suppressed abilities to bargain (including striking) and abandonment of full employment where as a society we targeted more hours of work than demanded. Currently, capital has the ability to pass on cost increases (or blindly profit gouge) and workers have little legal recourse to fight for higher wages.

And to make things worse for the working class, our governments claim false fiscal constraints about needing to ‘balance books’ claiming it is too expensive to provide universal social services and allows corporations to profit the services we need!

Conclusion

I’ll let you draw your own conclusions on the RBAs decision to hike rates. I think increasing mortgage costs on heavily indebted households is not a great way to reduce inflationary pressures. Monetary policy is a blunt tool that should be tossed into the bin. Any increase in unemployment will be caused by the contraction in spending and may have a negative impact on the CPI, but it hardly solves any of the supply issues and creates more jobless!

We need a populist left agenda around a public bank option with low to zero interest rates on our homes and heavy regulated credit rules (to keep land affordable). I would also merge the current tasks of the central bank into treasury and create a government body in charge of monitoring supply bottlenecks and preparing the best ways to mitigate them and dare I say it use price controls to keep our essential items affordable.

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