Are there ways to combat inflation other than by raising interest rates?

Dr Shane Oliver, Chief Economist at AMP, discusses the impact of interest rates and alternatives for fighting inflation.

Stephen Mackinder: We're joined today by Dr Shane Oliver, who is Head of Investment Strategy and Chief Economist at AMP. Shane has been described as economist extraordinaire, commentator, educator, entertainer, optimist, and Beach Boys fan. Shane has worked at AMP for the last 39 years since leaving university, and is known by a lot of Australians as the face of AMP. It's my pleasure to welcome you today to Financial News Network.

Shane Oliver: Thank you, Stephen. Thanks for having me.

Stephen Mackinder: You're very welcome. I'd like to get your thoughts on the following topic, if I may. Is there a better way to kill inflation rather than rising interest rates? In an article written by ABC's business reporter Gareth Hutchens a few months ago, Mr Hutchens made the point if the RBA is going to force households to hand over more of their income during inflationary episodes like we have at the moment, and this would therefore stop them spending, why shouldn't households get to keep some of that money for the future? He also suggested, if we all make extra savings into our superannuation of, say, 2 per cent of our income for a two-year period, this would have a threefold effect. It would generate investment returns for those households for future use. It would delay consumption now, therefore, curve inflation. And the savings effort would be fairer because it would be spread across all income-earners, not just the people with mortgages. So, can you share your views about these three components and what your take of it is?

Shane Oliver: I guess the first aspect is, is there a better way? And the answer is that there certainly is. It's not optimal that interest rates are the only lever we have to control inflation. The problem is, I guess, grounded in what you call political economics. In an ideal world, to slow inflation, you want to take money away from people to slow things down. And you could do that by raising taxes, cutting government spending, raising interest rates. Of course, you could increase superannuation contributions, and there's lots of details within all of that.

The problem, of course, is that, if you go back to the 1970s and '80s, back at that point in time we did use a broader array of measures to control inflation. The problem, of course, is that governments can't be relied on to take money away from people because it's not in their political interests. Voters don't like it, particularly if we're getting close to elections. And the history had been that governments had not had a good track record of controlling inflation. Of course, South American governments, totally hopeless. They even controlled central banks down there and printed money and often ended up with hyperinflation. So, the theory was that you'd give the responsibility for controlling inflation to the central bank, give them an inflation target and rely on them to adjust interest rates to do so. So, that's how we ended up with where we are now, and I think it's a realisation that the politics can't be relied on to get it right.

Does it make sense to ramp up and ramp down superannuation contributions? Maybe. In an ideal world, you could say, "Give that lever to the RBA," and get them to do it rather than leave it in the hand of the politicians, and I'd be in support of that. But you would have to have a situation where it could go up and go down again. I think people would get very annoyed if it went up and never came back down again. So, it'd have to average out over time, much like, in theory but not always in practice, interest rates do.

You've also got to bear in mind that there would be quite a bit of a backlash against that. But, then again, it wouldn't be that much different to the backlash we're seeing currently against higher interest rates. Some people would say, "I don't want to put more money into my super now. I need that money now to cover the cost of living." But, of course, that's a bit like saying, "Well, I don't want to pay a higher interest rate. I need that money now to cover the cost of living pressures I'm experiencing."

So, yes, it's a good idea, it makes sense. That money would be put to use in the broader community, to invest in infrastructure and other things, and people would have it in their long-term savings rather than having it gone forever, so to speak. So, I would tick it off as a good thing to consider.

Is it going to happen? I'd say probably not. Because I can't imagine a government agreeing to that or giving that power to the RBA. And if it is left in the hand of government, I wouldn't rely on them to get it done in a timely fashion.

Stephen Mackinder: Okay, thanks. Shane, in Australia, we have three main groups of householders. We have those who own a home with a mortgage, we have the renters, and we've got the people who own their own home freehold, and they tend to have some money in the bank. So, when the RBA increases interest rates the way they've been doing, initially, it affects the homeowners with the mortgage, as we all know. But this in turn is passed on to the renters. Because the landlords have higher interest rate payments, so they pass those extra costs on to the tenants by way of higher rent. And then we've got the people who are freehold with money in the bank who are actually getting more income off their high-interest savings and their term deposits. Is this a fair way of expressing the impact of increasing interest rates?

Shane Oliver: Well, it's certainly a way. And in terms of the three household groups, that is the way it works. The bulk of the pain is felt by those with a mortgage. And, of course, investors also experience pain. They're part of that, and they try and pass that on as far as they can to renters. They can't always do that. If you don't have a strong rental market, for example, then it's hard to get rents up. Right now, we do have a strong rental market, though, and you can put rents up. And, of course, the household sector that benefits are that group that has money in bank deposits.

So, you are effectively transferring money or wealth from one group of the community to another group. Obviously, when interest rates go down, it goes the other way. You are taking money away from savers, people with bank deposits, and giving that money effectively to borrowers. Now, we're going through a situation where it's the reverse. You're taking the money away from the borrowers and giving that money to savers.

If you think about it, that has the net effect of slowing things down. Because the borrowers are often borrowing to invest, so that slows down investment. And, also, there's a cashflow impact that homeowners with a mortgage have less cashflow left over, and so have got less money to spend. Obviously, there's that other group who do have more money as their bank deposit rates go up, or alternatively, if they've got money in the short-term money market. But they tend to be less responsive to changes in their income. So, the net effect on the community is that, as interest rates rise, it has a dampening impact on things. Because the younger people with the mortgage have to cut back their spending to keep making their mortgage payments. But the older people like me and, say, my mother, we don't change our spending that much around — even though the bank deposit returns go up or our investment returns might go up, we don't change our spending that much. So, net-net you still get a reduction in overall spending in the community.

So, it sort of makes sense in a way. But the only problem I am conscious of is that there are distributional aspects in all of this which in some ways seem unfair. Obviously, you've got a small group, or a group, one third of households in particular, and those with big mortgages, so borrowers, more recently, who are paying a big price and obviously experiencing much higher interest rates.

I guess someone might come back to me and say, "Well, Shane, you know, interest rates have been falling for 30 years since 1990. So, that's benefited home borrowers to some degree, over that period, at the expense of people with bank deposits. Now, we're just seeing a bit of reversal of that." But I don't think recent home borrowers would necessarily see it that way because they got in a few years ago when house prices were at the top, paid top dollar, took on massive amounts of debt compared to what my generation did, and now they're paying the price for that. So, there are distributional aspects which I think need to be thought about here. In other words, whether it's fair that one group of community bear so much pain, whereas the other group sort of sail through it.

Stephen Mackinder: Thanks for that. So, banks operate on a margin of around 2 per cent on top of their cost of borrowing. If a mortgage-holder is paying 6 per cent interest on their home loan, therefore 4 per cent of that is being paid to the RBA. Or where? So, my question is really, what really happens to the interest, the extra interest that homeowners are actually being forced to pay every time the interest rates are increased? What really happens to it apart from the 2 per cent that the banks are using?

Shane Oliver: Well, let's assume the 2 per cent margin remains the same, therefore banks don't benefit out of it, and interest rates go up, so borrowing rates go up, whether it's… So, the banks get roughly — I can't remember the latest — 50 or 60 per cent of their money from bank deposits. So, in theory, the banks raise their bank deposit rates. But, more importantly, the Reserve Bank also influences the overnight borrowing rates. And that means anyone, say, in a cash management trust will see their interest rate go up as well. So, effectively, you're transferring money from borrowers to lenders in the community. So, there is that wealth transfer effect. It doesn't necessarily end up in big amounts of money sitting at the Reserve Bank or at the Federal Government. It's not like a tax hike. But you are transferring money from one group in the community to another.

The other aspect, I guess, in all of this that's happened is that that impacts people with existing debt and existing savings or investments. But you've also got this reality that, as interest rates go up, it reduces the attractiveness of investment, whether it's someone borrowing to buy a new house or someone borrowing to invest in their business. And so that also has a dampening impact on the economy.

But, again, it's a transfer from one group in society to another. It's not money that sort of disappears into thin air, so to speak. Because if that were the case, the flip side would have been, as interest rates, mortgage rates fell from, say, 17 per cent to 2 or 3 per cent a few years ago, that there would have been a massive increase in free money going around. Things were good, but they weren't that good.

That's effectively what's happening. You're taking money from one group, you're giving it to another group. How that other group gets that money varies. Obviously, it's clear for depositors. But for the money that the banks get from the money market, it does benefit investors in the short-term money market.

Stephen Mackinder: So, we'll get onto the fairness of it. Given the current state of the economy, both globally and locally, how does the rising inflation and rising interest rates, how does that truly affect the Australian on the street?

Shane Oliver: Well, I guess you can always debate this one. It's a bit like, if we have a recession, how will people be affected by that? Sometimes it's just the noise around you. As the global economy struggles, as the Australian economy slows down with that, then people feel a sense of unease. You know, the reality is that when times get tough and unemployment goes up, most people still keep their jobs. But there's still a sense of unease around that.

People right now, with very low unemployment, feel a degree of job security. Because they know if they lose their job in one place, they'll probably get another one in another place. And, likewise, they feel that, given unemployment is so low, they're in a good position to get higher wages growth. If we move into an environment of, say, recession, starting globally and then in Australia, which you'd have to say is a reasonable risk… Central banks have a habit of going too far with their interest rate hikes and overdoing it. Fortunately, we haven't done that for a long time in Australia, but we certainly did that through the '80s and into the '90s. If that happens, then I think Australians would start to feel a sense of unease around them.

Most would keep their jobs. Unemployment would go up. But even if unemployment goes up, say, five percentage points from 3.5 per cent to 8.5 per cent — that's the similar rise that it had back in the early '90s and early '80s — most people, 90 per cent plus, will still keep their jobs. It will be felt, I think, more via lower confidence levels, less job security, people less inclined to ask for big wage rises, people staying in the job for longer. Well, I can't talk, I've been in the same company for 39 years, but other people do move around. So, that's how it would be felt. And people will therefore tighten their belts, so to speak, and spend less.

And, interestingly, we're already starting to hear more anecdotes about that. I know lots of people say, "Well, everyone's in Europe at the moment," and I had a trip there a few weeks back, but that I think is partly pent-up demand. In our case, my wife and I, we were thinking of going there three years ago. It didn't happen because the pandemic, so you go now. Some people have got to use up credits that built up from trips that were cancelled back then. I think there's a temporary aspect to that, that's not going to continue indefinitely. But you are already seeing it in shop owners, shop owners saying, "Well, things are getting a bit tougher here." I was at a sale the other day, a local clothing shop, and she had to extend her sale. She said, "Look, I've just got too much stock here. Demand has slowed down." And you're hearing that story more and more. And people will feel it that way as well.

On the one hand, there's a benefit. You've still got your job, you can go to the shop and you can get stuff cheaper. There's more sales around. On the other hand, though, you might be feeling a bit less comfortable about things, which may make you less inclined to spend. And if you are going to spend, more inclined to look for those discounts. Yeah, I'm happy to buy a new suit, but I want it to be on a 20 per cent discount in a sale, for example, rather than top dollar at regular pricing. So, that's how it sort of changes things.

But I was around for the '80s and early '90s recessions. They're not good things to be in. The best trick is to avoid them. And I think one of the key things on that front right now is for the Reserve Bank not to get carried away with rate hikes. And I fear that they are already doing a little bit too much of that.

Stephen Mackinder: Yeah. As someone who paid 20.5 per cent on their first home loan, I remember those days pretty well.

Shane Oliver: Yeah, they were a bit rough.

Stephen Mackinder: Weren't they? So, Shane, in your opinion, what do you think the RBA should be doing to combat inflation? Or should it really be tackled by a combination of the RBA and the government? Either way, what would be a viable and productive strategy in your view to help deal with this issue?

Shane Oliver: I think, in an ideal world, it should be a mix of things. I'm talking here as an economist. Putting aside the politics, it should be a mix of things. Yes, the Reserve Bank would have had to tighten monetary policy because it was very easy going into the pandemic. They had to raise interest rates. They couldn't stay at zero forever. So, there's a bit of that.

Arguably, the government should have been cutting back spending where it could. I'm not saying cut welfare payments, but we hear in some areas that it's hard to get infrastructure projects done, to slow that down a little bit, to take pressure off, say, the building industry. Likewise — and people won't appreciate this — you could have made a case for a temporary increase in tax rates within all of that. I wouldn't say increase the GST. I know a lot of people say that, increase the GST. But the GST also has a direct impact on inflation, and that could backfire in some ways. So, if you're going to raise tax rates, it'd have to be personal tax rates as part of an ideal package of solutions to spread it across all income groups, particularly higher income groups.

And then, finally, I'd certainly look at the superannuation option. That's probably my preferred one. I don't like to push that one too hard because I do work for an organisation that has financial planners and has superannuation monies, and so I might be seen as pushing my own barrow. But by the same token, as I said before, it should be temporary and it should average out over time.

So, I think that's an ideal one. You should have a mix of policies designed to spread the pain around. Can't get away from the fact you have to tighten monetary policy, but it should be much broader than that.

Problem is, I'm also a political realist. I don't think I can trust governments to do that in a timely fashion. They didn't do it in the 1970s, early '80s. So, I think, unfortunately, it still rests on the Reserve Bank, which is a rather dismal thought, but that's the reality. Unless governments can show that they've changed things. Or alternatively, we can give the Reserve Bank more levers. If they had control of some sort of countercyclical fiscal lever, maybe super, then that would be a good thing. But unless we can agree to do that, I'd rather stick with the Reserve Bank doing it because I'd rather trust them than others.

But that still leaves a situation where the Reserve Bank might get carried away and go too far. And that's the thing that worries me a little bit at the moment, that they are not allowing enough for the lags of monetary policy, and therefore potentially end up overdoing it, much as they did in the late 1980s. They kept hiking interest rates, you ended up with your 20 per cent mortgage rate, and others up there as well. And the argument was, "Well, the unemployment rate's still falling, the economy's impervious." And then, of course, it was okay till it wasn't. And then we had the recession we had to have, or I think didn't have to have. So, that worries me about the Reserve Bank.

But until I can get the politics under control around countercyclical policies, I'd still rather the Reserve do it, because they're politically neutral, rather than politicians.

Stephen Mackinder: So, what would it take for the Reserve Bank to be given that power?

Shane Oliver: A backlash from the Australian community, a debate basically. Obviously, we are seeing a little bit of that now. But I think for them to get that power, you really need a community debate about this, a realisation that what is occurring is not really fair, but there are better ways of doing it. And therefore, a consideration as to what might be the best lever to give the Reserve Bank, whether it's taxation — most people wouldn't agree to that — but maybe superannuation, there might be more support for that. And I'm not talking about the underlying level of the superannuation rate. I don't think they should be charged with determining the ultimate rate that it gets to. I'm talking about the cycle around that where they're given a potential to increase it by one or two percentage points in times of high inflation and cut it in times of lower inflation.

But I think you really need a community debate around this. We're starting to have a bit of that. I suspect, though, that by the time the debate has hit full swing, inflation will be falling again.

Stephen Mackinder: We'll be out of the cycle.

Shane Oliver: And we'll be back onto something else.

Stephen Mackinder: Yeah. Shane Oliver, thank you very much for your time and your valuable input. It's been a pleasure.

Shane Oliver: My pleasure. Thanks again for having me.