The easing cycle to come risks being the same as the last

Monetary policy in Australia has been through a period of review, change and intense scrutiny. With a new year, a new statement of conduct and potentially a new direction for rates this year, the Reserve Bank of Australia (RBA) arguably also has once-in-a-generation licence to do things a bit differently.

Globally, the year is shaping up as one where central banks cease their aggressive policy tightening in favour of some cautious easing once inflation allows or their economies demand.

The RBA may or may not be among them, some think cuts will come sooner and some later. It will depend on our own, potentially idiosyncratic, inflation outlook. But the one thing we can be sure of is that the current high levels of interest rates in Australia will at some point decline. The expectation is that the RBA to cuts rates as it has always done and economists will model the same outcomes. Whilst at the same time risk ignoring recent pre-pandemic history that highlighted that lower and lower rates assist at the margin but are not the solution to many of the economy’s problems and indeed may exacerbate them.

The rationale for lowering rates is simple and largely unchallenged: support the economy as much as possible, while maintaining inflation within the target band. As are the key tenets of the lower interest rate playbook – disincentivize savings, free up borrower cash flow, push up asset prices and make borrowing more attractive.

But does this still hold? And are these the outcomes we want? After a period of intense public scrutiny, a formal review and a change of Governor, the RBA has an opportunity to do things a little differently. As it has met for the first time in 2024, here are some ideas for it to consider for the year ahead.

For example, should the RBA, armed with its new Statement on the Conduct of Monetary Policy, communicate what a ‘better’ balance between full employment and inflation might be in the current circumstances and those expected going forward?

Would it consider calibrating policy, that is lower rates sooner, to keep unemployment as low as possible and facilitate real wages growth that might allow households to ‘catch up’ on prices that have risen - on average - permanently higher even if it risks slightly higher rates of inflation. Such a course may also serve to spread the load of disinflationary policy beyond the central bank with targeted responses that are much less impactful on the labour market.

We have recently seen the importance of people keeping their jobs through a cost-of-living crisis in supporting the overall economy and managing levels of individual household financial stress.

However the Bank chooses to ease, it is well known that lower rates historically lead to asset prices rising in excess of income growth, higher dwelling prices, more household debt, undermining affordability and exacerbating inequality. This will threaten to again be the case again in the coming easing phase. But do we need that when we already have one of most indebted household sectors globally and so many locked out of homeownership due to affordability issues?

Many would argue these effects are important growth drivers needed to support spending and kickstart the dwelling construction cycle. But equally we have experienced how price booms invariably see first home buyers crowded out of the market. And how high debt levels impact households negatively both economically and socially over the medium term.

Could, therefore, the RBA and APRA who we are told will be working more closely together, tilt the playing field in favour of those aspiring for a first home rather than upgrading a current one?

A tiered system of borrowing costs, implemented by lenders, could be put in place so that first home buyers are able to access lower rates than upgraders or those buying their second or third established dwelling. This could also be extended for investors in new dwellings to incentivize additional housing supply – again helping first home buyers, as well as renters.

This would still see rates support the construction cycle and its important multiplier effects via household formation. It may also serve to limit outsized dwelling price growth, keeping it more in line with incomes and/or nominal GDP and assist with affordability.

It might also be useful for the RBA to take a different approach to its communication. Firstly, by outlining what it expects to achieve by easing policy for the economy more broadly. And secondly highlighting the challenges that other policy settings present in achieving those outcomes.

This would include a more rigorous discussion of the broader economic and policy environment and its structural issues that monetary policy is all too readily co-opted into patching over. That as we saw was the experience in the decade before the pandemic with lower and lower rates .

Could the RBA’s new ‘policy Board’ – the members of which are required to make one public speech per year - play a more proactive role in leading broader discussions on economic policy as they pertain to monetary policy settings? This type of discussion is something the RBA has traditionally shied away from. But given its independence and research capability it seems uniquely positioned to do this.

Productivity is but one example among these structural issues. An area the RBA has little scope to impact other than squeezing businesses but clearly the lack of productivity growth impacts monetary settings. This may be uncomfortable ground but there are few if any advocates for change. Even the Productivity Commission itself, while putting ideas on the table rarely pushes them publicly (something that hopefully may change under its new leadership).

The few ideas I’ve put forward may seem contentious, but to me so does doing things the same way as we always have. The decade preceding the pandemic was one of lower and lower rates, but few would argue this made the economy better, more robust, or more equitable. Indeed, economic growth during this period could best be described as anaemic.

The recent review and reform of the RBA should not just be about being able to scrutinize its activity more rigorously and it being more collegiate internally and externally. It should also be about evolving monetary policy to secure better outcomes for the economy and the people in it. The RBA has been gifted a moment to seize this opportunity, if it doesn’t it could be an opportunity lost.