Central banks are prepared to pull out all the stops to avoid the Great Inflation of the 1970s, an economist has said.
Central banks, including our very own the Reserve Bank of Australia (RBA), have become “a lot more aggressive” in raising rates partly because memories of the prolonged period of ballooning inflation in the late 1990’s are still very fresh, Dr Shane Oliver said on a recent episode of the ifa show, hosted by InvestorDaily’s sister brand.
“Memories for those that looked at the history books or who were around at the time go back to the 1980s when the US central bank under Paul Volcker decided to squeeze inflation out of the system. And then we had two back-to-back recessions in the US, we had a recession in Australia,” Dr Oliver said.
“That's the big worry here. And obviously the risks have gone up because you've got all these shocks on top of each other,” the chief economist added.
It’s no secret that the RBA was fairly surprised by rapidly burgeoning inflation. Just months ago, the central bank was stubbornly reiterating its 2024 rate target, before rapidly pivoting at the end of 2021 with the abrupt removal of the yield curve having realised that things weren’t moving in the predicted fashion.
This, according to Dr Oliver and the RBA’s own Philip Lowe, severely impacted the RBA's reputation.
Moving forward, Dr Oliver believes that the RBA’s best course of action is to lift interest rates “relatively aggressively” in the short term before pausing to reflect later this year.
“I think at the end of the day, we're not going to see the interest rates at 4 per cent, which is what the money market's talking about,” he said.
Instead, Dr Oliver is confident that rates will end up at around 2.1 per cent in December.
“We think that given the heightened sensitivity of Australian households to higher interest rates because of higher debt levels, that the Reserve Bank won't have to and won't go to those very high levels,” Dr Oliver noted.
“I think the Reserve Bank is not stupid, it knows that there's more debt out there. It knows that people are more sensitive than in the past to higher interest rates. And it also knows that there's been a big blow to household income,” he continued.
“So, I think the Reserve Bank won't ignore those things and therefore they won't have to raise interest rates as much as many fear in this environment.”
In June, while admitting reputational damage had been caused by some of the bank’s more questionable moves, the RBA conceded that, with the benefit of hindsight, the yield target could have been ended earlier.
“In retrospect, given the evolution of inflation and the labour market, an earlier end of the yield target would have been appropriate,” it said in a report summarising its review into the use of the yield curve control policy.
The RBA is expected to be subjected to an independent review shortly. In May, some of Australia’s top economists penned a letter to Treasurer Jim Chalmers demanding that a review of the RBA be headed by an “internationally recognised foreign expert”.
The bank has not been subject to a review since the early 1980s.
Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.
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