On Tuesday the Reserve Bank of Australia (RBA) surprised everyone, hiking rates by 25 basis points to combat persistent inflation (financial markets were pricing in 100% chance of no change).
The usual suspects wasted no time reaching for their pitchforks. Daniel Andrews, Premier of Australia’s most indebted state, Victoria, blamed the RBA for his own government’s lavish spending:
“I remember at national cabinet being told, ‘Go and borrow. If you don’t borrow, then we’re going to have 25% unemployment, we’re not going to get through this, we will not survive this. And by the way – interest rates won’t be going up’.
“The government of Victoria made decisions, but the advice that informed those decisions were very simple – you’ve got to borrow to get through. So of course we went and borrowed.”
Not to be outdone, the leader of the Greens, Adam Bandt, called on the government to “step in”:
“The government has the power in existing legislation precisely for crisis moments like this to step in and say, the Reserve Bank shouldn’t have to do all the heavy lifting. We, as a government, are going to do it instead. Freeze mortgage rates, freeze rents, freeze power bills, we are in a crisis, we are going to make big corporations and big banks pay their fair share of tax to deal with this crisis.”
That “existing legislation” to which Bandt is alluding is the power of the Treasurer to overrule the RBA, a power the recent RBA review listed as its first recommendation of things to dump. Exercising that power now would be a drastic move that would undermine decades of central bank independence and cause immense institutional uncertainty.
But while Andrews' comments are simply an attempt at averting responsibility for his own reckless actions, Bandt’s claims are beyond foolish and bring to mind Adam Smith’s famous observation that “there is a great deal of ruin in a nation”.
Essentially, a country can handle a whole lot of stupid but it’s not unlimited. If Adam Bandt got anywhere close to the country’s policy levers, we’d certainly be at risk of calamity.
Why? Just think through Bandt’s proposal for moment. What does Bandt see happening if the government undermined a pivotal institution in the RBA, while simultaneously freezing prices across the board? I’ll tell him: it won’t be socialist nirvana. Foreign investors, on whom Australia is greatly dependent, would rush for the exits (or at the very least reconsider future investments). The dollar would tank, and our federal and state governments would struggle to issue AUD-denominated bonds at any price, forcing interest rates and debt serviceability costs up considerably.
Then there’s the damage to the domestic economy: Bandt’s price freezes would remove important signals. If prices cannot ration supply in an economy with excessive demand – caused, in no small part, due to the borrowing and spending people such as Daniel Andrews unleashed in 2020-21 – some other mechanism must take its place.
Bandt might honestly believe that if he were only allowed to “step in”, we would all be able to borrow at forever-low rates, live in well-maintained rental properties and run our aircons 24/7. But the reality of his policies would more closely resemble rolling blackouts and ‘power quotas’, no banks willing to issue mortgages except to the most qualified or well-connected borrowers, and an ever-dwindling number of properties available for rent – of considerably poorer quality.
The RBA is raising rates because it messed up in 2020-21. But so did our governments, which spent big during the pandemic and are still spending like drunken sailors! No one forced them into this; many other countries got through the pandemic while spending considerably less than Australia.
While the RBA may have publicly stated that the cash rate was unlikely to rise before 2024 – extremely naïve at best, malicious at worst – politicians are ultimately the ones who did the borrowing and spending, not the RBA. We can’t wish away the mistakes of the past, and rising interest rates are best thought of as those mistakes being realised, while also – and this is very important – preventing even more mistakes from being made in the future.