A Matter of Interest
The RBA, Inflation and Corporate Profits
He is one of the least empathetic of beings, a cold fish, bothered and irritated. Captured by the cradle of numbers (he is an economist); obsessed by the spreadsheet of projections that may never result, there is not much to recommend the chief of the Reserve Bank of Australia, Philip Lowe. Come to think of it, there is not much to recommend any of them, these high priests and priestesses, all of the same, pontificating cathedral.
What stands out regarding Lowe is his almost heroic lack of tact. He will forever be saddled with those remarks that encouraged many Australians to rush to the banks to take out loans. When asked at the National Press Club in February 2021 about his “pledge” not to raise the cash rate for at least three years, Lowe was defiant: “I haven’t pledged anything”; 2024 was merely a “best guess”.
The bank’s own internal review, published in 2022, noted that the RBA board had indicated in late 2020 and much of 2021 “that the first interest rate increase was not expected for ‘at least three years’, and then not until ‘2024 or later’.”
The confident assertion by Lowe and fellow board members proved to be a spectacular howler. “Given the outlook was highly uncertain, the board could have given more consideration to potential upside scenarios, including scenarios that could warrant raising the case rate earlier than anticipated.”
Of late, Lowe has done himself few favours. The RBA has presided over twelve increases in the cash rate; the current benchmark interest rate lies at 4.1%, with promises of further hikes. It is the highest level since April 2012.
In his cold fish style, Lowe has openly suggested that people could “cut back on spending, or in some cases, find additional hours of work, that would put them back into a positive cash flow position.” While social media is not exactly the ideal barometer at the best of times, a collection of remarks is worth noting. “Regardless of if you are left leaning, centre or right, everyone has a reason to hate this guy,” states a certain Chazwazza. Andrew Hughes (if that be his name) suggests that economists brush up on their “EQ courses in what they teach. Because people are those numbers.”
In short, the Reserve Bank, and other central banks vested with such powers, are often there to make lives miserable on the pretext of improving them. The error never lay with the public: they were told to shut up and shut shop for months, avoiding family, friends and life. All that time, government stimulus – for the fortunate – found their way into bank accounts, much of it unspent. The time for inflation was surely bound to come.
The picture of inflation, however, was always going to be more complex. In that regard, the RBA is curiously unimaginative in reading inflationary pressures, showing a continued fixation with wages and labour costs. While rising wages can tease the inflationary demon, what about other sectors of the economy, such as corporate profits? Not so, say a number of business leaders, adamant that companies are being unfairly singled out for embracing the profit motive.
The Australia Institute has a rather different view on this. Through its Centre for Future Work, it published a report in February arguing that 69% of inflation beyond the RBA’s target band of between 2% and 3% could be put down to burgeoning corporate profits. “Rising unit labour costs account for just 18% of that inflation.”
The post-COVID inflation phase, characterised by a decline in real wages, labour share of GDP, and record corporate profits stood in sharp contrast to the 1970s, when the opposite effects were felt. “This historical comparison confirms that fears of a 1970s-style ‘wage price spiral’ are not justified. Instead, inflation in Australia since the pandemic clearly reflects a profit-price dynamic.”
The report, authored by Jim Stanford, did something Lowe obstinately refuses to do: consider the resources sector, Australia’s single most dominant economic performer, as part of its economic analysis. “For the first time, in 2022,” states Stanford, “mining profits accounted for over half of all corporate operating profits in the entire economy.” But in Lowe’s analysis, revealed in his National Press Club address delivered in April, “the share of profits in national income – excluding the resources sector, where prices are set in global markets – has not changed very much over recent times.”
The obvious logic of the Australia Institute irritated the RBA as being a touch cute in its methodological assumptions. Stanford’s paper duly made the rounds in internal discussions. A briefing note from the RBA’s domestic activities and trade section claimed that, “Profits and inflation do not have a direct accounting relationship. To examine the profit-inflation relationship properly, one requires a model and a measure of markups.” Another RBA report, examining web data gathered from 58 firms and 25 million unique items, concluded that “rising prices tend to be associated with lower margins”.
In what could only be seen to be a campaign launched on behalf of big business and its followers, calls for repudiation and recanting followed. Economics academic Richard Holden demanded that the Australia Institute “admit their mistake and retract their so-called analysis.”
There was just one problem with the criticism of Stanford and company. Far from being methodologically unsound, other notable bodies had embraced it. As part of its 2023 Economic Outlook, the OECD, on decomposing the GDP of 15 nations, found “a significant part of the unit profits contribution has stemmed from profits in the energy and agriculture sectors, well above their share of the overall economy, but there have also been increases in profit contributions and manufacturing services.” It also found that “a large part of the higher unit profits contribution originates from mining and utilities, even in commodity-importing economies”.
Earlier this month, the President of the European Central Bank (ECB), Christine Lagarde, also focused attention on the role played by galloping corporate profits in pushing up inflation. The data on corporate profits, she rued, was simply not as good as it was on wages.
On this score, the economic managers in Australia have revealed themselves as callous and conservative. Bedazzled by the extraction industries and unable to pursue a productive agenda, they continue to wage war on those irritating wage earners who demand absurdly modest increases to keep pace with inflation. As long as Lowe and the RBA are allowed to do it, more harm is in the offing.