Reserve Bank Rate Hikes Leave Households Exposed

The Reserve Bank has raised interest rates to their highest level since the global financial crisis, hitting mortgage holders, slowing the economy and reversing some gains in the jobs market. Now the government faces pressure to cut spending in the name of fighting inflation, even as those cuts could weaken services and economic growth. The squeeze lands on households already carrying the cost of higher rates.

Treasurer Jim Chalmers says the government will play a “helpful role” in fighting inflation, with savings expected in next month's mid-year budget update. Reserve Bank governor Michele Bullock, meanwhile, has said the government must provide goods and services including Medicare and income support payments. The institutions setting the terms of the debate are weighing price growth against public spending; people who rely on services and support will live with the consequences.

Who Pays for the Squeeze

Australia Institute economists Matt Grudnoff and Greg Jericho said government spending has played a diminishing role in economic growth, particularly when population growth is considered. The economy grew 0.4 per cent in the June quarter, but output per person didn't increase from the previous quarter. Without government spending, the country would have entered a per-person recession. Government spending accounted for about one quarter of growth in the June quarter.

The figures from the previous quarter sharpen the warning: in the three months to March, the economy grew 0.3 per cent while per-person economic growth fell 0.1 per cent. A recession is defined as two consecutive quarters of negative economic growth. Cutting spending may ease demand, but the numbers show public spending has also helped prevent a per-person downturn.

Recessions don't distribute their damage evenly. People who lose jobs can take years to regain their former salaries, and some never work again. Low-income households and younger workers seeking a foothold in the jobs market are hit disproportionately, deepening inequality. Businesses may also cut research and development, while innovative start-ups may fail.

Price Pressures Beyond the Budget

The Reserve Bank says it isn't yet seeing the economy “cracking” and has pushed back against suggestions Australia is at risk of recession. Bullock has acknowledged Australians are poorer and feeling the effects. Commonwealth Bank of Australia and National Australia Bank forecast growth slowing to about 1 per cent next year, while HSBC chief economist Paul Bloxham, formerly an economist at the Reserve Bank, put the chance of recession at 50 per cent. The article describes the economy as “on a knife's edge.”

Some price pressures come from outside the reach of the government and the Reserve Bank. War in the Middle East has pushed up oil and fuel prices, raising costs for goods and services made, produced or transported using those resources. The global artificial-intelligence boom has increased demand for data-centre construction and raised prices for energy, memory chips and construction workers.

About 70 per cent of the spending from that boom is going overseas, through profits for overseas owners or payments to overseas suppliers for imports. Because imports are subtracted when economic growth is calculated, much data-centre spending is slowing the Australian economy. The government can limit approvals for data-centre construction, but that won't stop global resource shortages from pushing prices higher; restricting AI development also risks leaving Australia behind in gaining its productivity and economic benefits.

The Choices on the Table

Possible savings include winding back some private-school subsidies, which the Australia Institute says could save up to $21 billion a year; reducing superannuation tax concessions for high-income earners, which it says would return $65 billion in forgone revenue; and abolishing the luxury car tax exemption for large utes, which would save $250 million a year. The article says those vehicles impose costs including higher carbon emissions, road damage and safety risks.

Higher interest rates leave many households with less money to spend, while helping dampen price growth. Government spending adds to demand and can increase price pressures when supply is limited, yet it has also prevented a per-person recession. The Australia Institute said: “If the price of doing that is having inflation that has been largely caused by external factors, still elevated for a longer period, then that is a price we should be happy to pay.” The debate is framed as a choice between prices and spending. The costs of getting that choice wrong don't fall equally.