The problem for the Treasurer, however, is that despite the severe financial stress suffered by many households, the Reserve Bank’s focus is – and must be – on bringing aggregate demand back into balance with aggregate supply.
As RBA Governor Michele Bullock pointed out last week, while it is difficult for many to make ends meet as the prices of goods and services have risen significantly and rising interest rates are straining the finances of households with mortgages, “the statutory objectives are “The bank’s economic viability is wide-ranging, and our most important tool – the interest rate – is blunt.”
Bullock’s speech also contained a thinly veiled warning that the RBA’s rate hikes have, at least so far, failed to boost demand enough to curb inflation. This means that the central bank will most likely have to raise interest rates further at the beginning of next year and keep them at a high level.
The prospect of further interest rate rises will come as a shock to many people who, as financial stress mounts, conclude that the RBA is certainly nearing the end of its monetary tightening cycle.
The problem for the RBA is that, despite raising its official policy rate to 4.35 percent from 0.1 percent in April 2022, Australia is one of the few countries where real (or inflation-adjusted) interest rates are negative.
And it’s clear that the fact that interest rates are below inflation – Australia’s annual consumer price inflation rose 5.4 per cent in the September quarter – is helping to boost housing activity.
The continued strength of these housing approvals suggests that many people have concluded that money remains relatively cheap despite rising borrowing costs. And given that construction costs have risen sharply and will likely continue to rise, it makes sense to take out loans to add an extra bedroom or even an extra floor.
Those who can afford it therefore push ahead with new housing construction or renovations instead of waiting.
One of the ways higher interest rates slow the economy is by causing a sharp decline in housing construction, which leads to weaker demand for labor and materials and reduced spending on new home furnishings. The fact that the value of residential building permits continues to trend higher than in the pre-pandemic period suggests that aggregate demand will remain stronger than expected.
Especially since the boom in public infrastructure spending continues to ensure strong demand.
Although Canberra has made some modest attempts to curb some spending, these cuts will have little impact as large projects invariably take longer and cost more to build than initially expected.
Because of the long delays in infrastructure projects, there is no chance that Canberra’s cuts will result in the short-term drop in overall demand that Bullock needs.
The government is also unlikely to support major spending cuts given widespread fears of rising pressure on the cost of living. And that means Chalmers will face the divide between disgruntled voters upset about their declining living standards and an economy in which, as Bullock noted last week, aggregate demand continues to exceed supply.
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