Why further interest rate hikes by the Reserve Bank won't fix Australia's inflation problem

If only there existed a diagnosed ailment dubbed One Size Fits All (OSFA) syndrome.

Chances are, if such a condition were recognized, a significant portion of our economic pundits might find themselves stepping out of their therapists' offices and making a beeline for the nearest pharmacy in search of relief.

In recent months, a notable shift has occurred among our economic prognosticators regarding the trajectory of interest rates.

What was once a nearly unanimous call earlier this year for multiple rate cuts has suddenly given way to predictions of potential interest rate hikes. Even those skeptical of higher rates have embraced the notion of a "higher for longer" scenario.

Undoubtedly, inflation, while still receding, is no longer dissipating as rapidly as before, and its manifestations are becoming less uniform.

The costs of consumer goods like clothing and household items are on the decline. It's not merely that price increases are decelerating; they're actually becoming more affordable.

Conversely, essential services such as rent, healthcare, and education are witnessing significant price spikes. This trend has contributed to an uptick in core inflation on a quarterly basis.

Promptly, this resurgence has reignited calls from certain quarters of the economic commentariat for additional rate hikes to decisively tackle inflation once and for all.

The playbook is clear: when inflation rears its head, raise interest rates relentlessly until it is subdued, regardless of the fallout.

Historically, this approach has yielded results. Many have deferred purchases or scaled back on non-essential spending items.

However, there are expenditures over which consumers have little control. This raises a critical question: are our decisions regarding accessing healthcare, securing housing, or pursuing education influenced by interest rates?

If the answer is affirmative, the ramifications could be severe down the road. Yet, we cannot selectively pay a fraction of our rent or opt for truncated schooling weeks to curb expenses.

As the Reserve Bank convenes for its latest board meeting, while interest rates are anticipated to remain unchanged, there may be indications that inflation will persist as a challenge for an extended period. The tone of the accompanying statement could unsettle the federal government's plans.

A mere week hence, Treasurer Jim Chalmers will unveil a federal budget initially intended to focus on stimulating growth rather than curbing inflation, a narrative that gained traction when it seemed the economy was rapidly decelerating.

However, the current landscape is fraught with uncertainty. Inflation is declining, albeit not as swiftly as anticipated, while robust employment and wage growth persist. Concurrently, property prices have rebounded to historic highs, bolstering arguments for additional rate hikes.

Yet, at the household level, signs of strain are emerging. Savings are dwindling, and retail sales have been lackluster for much of the past year, with recent figures indicating a worrisome decline. Moreover, insolvencies among small and medium-sized enterprises have reached unprecedented levels.

The prevailing buzzword is "sticky." Inflation, particularly in services, exhibits resilience. This divergence between tradable goods and domestically influenced goods and services underscores a homegrown inflation challenge, prompting apprehension among economic experts.

However, a retrospective examination reveals that prior to the pandemic, inflation for non-tradable goods consistently outpaced other sectors. The current lag in its decline prompts a pertinent question: do additional rate hikes offer a viable solution?

Consider the surge in rents, which escalated by 7.8 percent in the year ending March, marking the sharpest increase in 15 years amid a national vacancy rate of 1 percent.

Housing, along with insurance and education, constitutes a significant component of the inflation basket. Could the soaring rents be attributed to inadequate dwelling construction to accommodate the influx of new residents?

This perspective posits that robust immigration exacerbates inflationary pressures, complicating the RBA's efforts to realign inflation with targets.

An alternative, more immediate approach to alleviate inflationary pressures could entail curtailing immigration to achieve a balance in dwelling construction, rather than resorting to rate hikes.

Combatting inflation necessitates equitable distribution of the burden. Overreliance on interest rates disproportionately impacts the young and heavily indebted, as underscored by the IMF's observation that Australian households, predominantly reliant on variable-rate housing loans, bear the brunt of mortgage rate increases.

Government intervention through tax and spending policies can complement the RBA's efforts. Yet, with impending tax cuts injecting billions into the economy amid inflationary concerns, the onus is on the government to navigate this delicate balance.

Rigid adherence to conventional theories risks overlooking changing dynamics. The era of the 1990s, characterized by astronomical interest rates, cannot be replicated verbatim. Globalization's ebb and flow, coupled with the energy transition, herald an era where past inflationary benchmarks may no longer hold true.

Elevated interest rates curtail spending, evident in restrained consumer behavior. Forcing vulnerable demographics to further curtail essential expenditures could precipitate a crisis surpassing the perils of inflation.