The Reserve Bank is not your friend

Here’s a piece I wrote for The Guardian, the day before the latest rate rise.

Westpac’s profit jump is no surprise when the RBA favours banks over households

The news that Westpac has announced an annual profit of $7.2bn for 2022-23, up 26% on 2021-22, will not surprise the millions of Australian families dealing with higher mortgage rates.

Westpac achieved this result even though, for most of the year, many households were still benefiting from fixed-rate mortgages at low rates, which are only now expiring. It seems highly likely that next year will be even better for Westpac and the other big banks. They can expect to set new profit records after a long period of low interest rates and relatively weak profits.

Westpac’s massive profit should also not surprise the Reserve Bank of Australia. In June this year, the RBA published a discussion paper looking at the impact of interest rates on bank profitability, which starts with the observation “there is widespread empirical support that lower interest rates are associated with a decline in banks’ net interest margins” (that is, the difference between the banks’ own cost of funds and the rate they charge to borrowers).

The RBA plays down this finding, arguing that banks may find ways to maintain profitability in a low-interest environment. But as far as ordinary households are concerned, it’s the margin between the return on savings and the cost of borrowing that matters.

It’s easy enough to see that higher interest rates help bank profits and harm borrowers. But interest rates go down as well as up. If the RBA were a neutral umpire, managing the economy to maintain stability in a way that benefits all of us, we could be comforted by the idea that the ups and downs will balance out in the long run.

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But the RBA is far from neutral. Like other central banks, it is committed to an inflation-targeting regime based on the idea of the Non-Accelerating Inflation Rate of Unemployment (Nairu), also called the “natural rate of unemployment”. This is, supposedly, the unique rate of unemployment consistent with low and stable inflation. As the Labor government’s employment white paper recently observed, the Nairu has several shortcomings as a measure of full employment. It evolves over time, is difficult to measure and does not capture the full potential of the workforce.

The Nairu-based inflation targeting regime serves to enhance the power and prestige of central banks, and of the financial sector as a whole. On the other side of the coin, the inflation-targeting regime has been part of the process by which the wage share of national income has been pushed down over the last three decades. What’s good for the RBA is not necessarily good for Australian workers.

What’s good for the RBA is not necessarily good for Australian workers

The conflict between the interests of the RBA and the demands of good economic management is starkly illustrated by the push for a rapid return to the 2-3% inflation range.

The 2-3% target range has never been supported by serious economic analysis. It was chosen in the early 1990s by the Reserve Bank of New Zealand (initially as a precise target of 2%). The target was a political compromise, seen as the lowest rate of inflation that could be achieved and sustained without risking a deep recession.

At the time, New Zealand was seen as a star performer in the cause of neoliberal reform. The prestige of the short-lived New Zealand miracle led central banks around the world to adopt the same framework.

Since the advent of zero interest rates in the wake of the global financial crisis, it has become evident that the target was pitched too low. Economists ranging from Olivier Blanchard (the former chief economist of the International Monetary Fund) to Paul Krugman have pointed out that a 4% inflation target would give more room for interest rate policy to stimulate the economy without hitting the zero lower bound.

In the recent review of the RBA, this issue was raised. But rather than address the substantive issue, the response (echoed by RBA supporters in the media) was that such a change would reduce the RBA’s “credibility”. Other things equal, a more credible central bank is a good thing. But in choosing how much to sacrifice to preserve this credibility, it’s evident that the institutional interests of the RBA are likely to be placed ahead of those of households facing higher mortgage rates or workers who risk losing their jobs.

Whether or not the RBA board meeting produces another rate hike, the rapid increase that has already taken place will continue to work its way through the system. The brief period of near-full employment we have recently enjoyed will come to an end, at least if the RBA is successful. And, in all probability, Westpac’s profits will continue to rise.

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