MNI INTERVIEW: RBA Should Pause Rate Hikes - Ex-Board McKibbin

The Reserve Bank of Australia runs the risk of over tightening should it hike further, as supply-side disruptions dissipate and inflation peaks, a former board member told MNI this week.

Warwick McKibbin, now Australian National University economics professor and an RBA board member between 2001-2011, said in an exclusive interview that energy and shipping prices have reverted to 2019 levels and supply shocks from Covid and the Ukraine war may have self-corrected. Further hikes will continue to slow an economy already decelerating due to the supply-side adjustments, he said.

A recent Institute of International Finance paper, the COVID Inflation Shock, Monetary Policy Gradualism, and Lingering Supply Chain Effects, called for more gradual monetary-policy adjustment, noting supply-side shocks had faded (see charts).

McKibbin said pushing inflation below the global level would be costly. Pointing to June’s monthly inflation read (MNI BRIEF: Aussie Monthly CPI Slows to 5.6%), he said the supply and demand adjustment dynamics suggested central banks risked overshooting as deflationary impulses pass through the global economy.

The RBA paused the cash rate on July 4 at 4.1%, citing June’s monthly inflation print (MNI RBA WATCH: RBA Pauses Despite Still Sticky CPI). The board stressed it wanted more time and a fuller picture on inflation. The Australian Bureau of Statistics will publish the more reliable quarterly CPI on July 26.

He noted a question persisted on how much demand had contracted due to monetary policy. He said the RBA should also closely monitor China’s poor economic performance, which will impact Australia greatly. McKibbin's comments echo fellow ex-board member Bob Gregory, who told MNI interest rates should hold at 4.1%.

According to McKibbin, evidence suggests global supply and demand imbalances cause inflation and the RBA’s monetary-policy settings have less impact relative to the global inflation impulses. Central banks across the developed world should take the opportunity to pause as supply and demand returns to normal, he added.

“The RBA should have moved earlier to hike in 2021, but now it runs the risk of being slow to stop if it decides to hike in August,” he added. “There's a wait-and-see case now, but the RBA must make it very clear why it is doing it.”

A GLOBAL ISSUE

Economies do not operate within closed systems and central banks, including the RBA, should evolve their “simple macro” monetary-policy frameworks, which state wages or the price of capital drives inflation, McKibbin said.

Labour in Australia accounts for 18% of total gross output as the country imports a lot of goods, he continued. Inflation springs from anywhere using intermediate inputs, a reason many countries experience it simultaneously, he noted. While a floating exchange rate should insulate the economy from international price shocks, McKibbin believes the world has become too complex and the number of imported goods too numerous.

“There's only one exchange rate and there's many prices,” he noted. Exchange rates cannot offset relative price changes – an energy shock will impact prices differently, while a depreciating Australian dollar will add to inflationary pressure as other central banks hike their rate faster, he argued.

"Central banks are not islands and the models they are using are not complex enough to understand these impulses coming through the global economy.” (MNI POLICY: BOE Hikes Whilst Seeking New Inflation Model)

Central banks must force some sectors to contract to lower inflation, he said. “They must have a framework they can explain, then they need to move away from inflation targeting,” he added, noting nominal-income growth targets were favourable. "If growth is weak, a period of temporarily inflation can help stabilise debt levels and GDP ratios.” He also called for more coordination between fiscal, monetary and climate policy, which has fast become a global call for central bankers.