John Hewson
The RBA risks bursting the household debt bubble

In many ways, the economy is a poisoned chalice for the incoming Labor government. So much for the Coalition’s boast of being “better economic managers” – perhaps they were just better economic manipulators.

The easing of insolvency and bankruptcy criteria during the pandemic is being reversed – meaning the numbers of these failures can be expected to increase significantly. Added to this, the Australian Taxation Office is set to resume its collection of tax debts totalling some $60 billion after it was suspended during the pandemic.

Many small businesses that managed to survive the worst of the pandemic recession are about to face some harsh realities. Short-term relief measures are also about to end – the cut in the petrol excise and the low- and middle-income tax offset. These tax increases will have a significant impact on the cost of living in many households. Moreover, petrol prices are already rising.

Beyond the termination of these measures, Morrison left no pathway to budget repair or debt reduction, simply some very vague statement about growth doing the job. But it doesn’t. Of course growth can make the debt numbers look better relative to the size of the economy, but it will not reduce the long line of budget deficits stretching out as far as the eye can see, nor will it actually reduce the roughly $1 trillion of debt. This was the first election in memory in which there were no firm commitments to return the budget to surplus. The budget repair task will require increases in taxes and/or expenditure cuts – it will require a challenging shift in honesty about the task. It is significant that the ratings agencies are warning of the risks to our AAA credit rating.

In the wages area, Anthony Albanese’s government inherits a mess. There are significant, indefensible, misaligned wage relativities that have exacerbated skills shortages and had serious impacts on the provision of many essential services, including nursing, aged care, disability and emergency care and teaching, to note just a few. Then there is the big legacy of the housing debt bubble and the role of the Reserve Bank, which presents us with the prospect of sustained increases in interest rates and mortgage stress.

It is instructive just how conscious the Coalition’s plan was to leave the economy in such terrible shape for Labor to grapple with in government. Peter Dutton, in his first press conference on being elected Liberal Leader, made it quite clear that his aim was to win in 2025, to clean up Labor’s “inevitable economic mess”. There was no evidence of the promised “softer Dutton”. He was Trumpian, hinting at a leadership style similar to Tony Abbott’s in opposition – more destructive than constructive.

The big unknown for our economy is the likely impact of the RBA’s increases in interest rates, after keeping them too low for too long. This accommodation helped Scott Morrison’s government to weather the pandemic recession, but it contributed to a significant overheating of the home-building sector, driving large increases in house prices. This culminated in big increases in building material costs and skills shortages – it should also be recognised that construction was one of the few sectors that was not locked down. The Australian Financial Review quoted then deputy RBA governor Guy Debelle, speaking virtually to a Perth audience in early May, as saying, “It is important to remember that while housing prices may not rise as fast without the monetary stimulus, unemployment would definitely be materially higher without the monetary stimulus.” This was interpreted as a statement that the RBA would not intervene to curtail surging house prices. Debelle noted there are several tools available to address distributional issues, but said, “I do not think that monetary policy is one of the tools … Monetary policy is focused on supporting the economic recovery and achieving its goals in terms of employment and inflation.”

Note that Debelle has since resigned to work for Twiggy Forrest on his climate projects – apparently not wanting to miss out on the employment and wealth opportunities arising from Australia’s transition to a low-carbon future.

These comments from Debelle on RBA policy underscore the delicate balancing act that the central bank must perform now it has begun raising rates. To move too fast and too aggressively could tip our economy back towards recession with unemployment rising again. This is a significant risk.

The other important dimension of this challenge is the plight of households, many of which have borrowed more than they can actually afford to service let alone ultimately repay.

In circumstances where costs of living are accelerating rapidly, the financial strain and stress of higher interest rates can be severe. Digital finance analyst Martin North has said that mortgage stress – defined as paying more than 30 per cent of a household’s pre-tax income in mortgage repayments – has risen to more than 41 per cent of households across the country, with the average mortgage now about 50 per cent bigger than it was before the pandemic. These are the consequences for people who already own their homes. For new home buyers, while a fall in housing prices may help somewhat, the orders of magnitude are now prohibitive. The average house price in Sydney and Melbourne is well over $1 million, and it may be impossible for young people to find enough money for a deposit.

Albanese’s promised housing scheme will be an early candidate for refinement and implementation. In addition, he will need to accelerate his scheme for the construction of affordable housing. This will be a real challenge for Dutton and the new parliament, to be constructive in facilitating the necessary legislation. It would be most disappointing if this were the issue on which Dutton decides to try to score points. I was disturbed to hear the RBA governor, Philip Lowe, in announcing the recent increase in the cash rate, attribute most of the inflationary pressure to supply-side constraints. If this were the case, an increase in interest rates would not do much to fix the problem, beyond perhaps restraining inflationary expectations.

Perhaps it is most timely that there be an independent review of the RBA, as called for recently by a group of leading economists. I assume such a review would not go to the bank’s independence from government but would instead focus on its policies and practices, as well as on its track record in forecasting and performance.

The main current worry about the RBA is that it will raise rates too far and hold them high for too long. Many of us remember all too well the interest-rate debacle of the late 1980s and early ’90s and its growth consequences, when mortgage rates reached the high teens and business base rates soared through the high 20s. That situation arose as the RBA was urging Paul Keating, as treasurer, to raise rates. The argument went that, given the political difficulties of the time, “if you don’t lift them early, you’ll have to lift them higher later”. The response precipitated the early 1990s recession. Not surprisingly, Keating ran the line “this is the recession we had to have”. But, of course, it wasn’t – it could have been avoided.

It is to be hoped that a recession will be circumvented this time.

One of the concerns about RBA monetary management over the years has been its belief that it can “fine-tune inflation”. It’s as if the governor sits at his desk with a black monetary-policy box in front of him. The box has two knobs, one for the cash rate and the other for inflation. The central bank would have us believe that by simply dialling the cash rate up in, say, 25-basis-point units, it is able to dial inflation back towards the target range.

If only it were all that simple, and if only the financial system worked in that way. Households are much more exposed now than they were in the late ’80s. Debt among households is at record levels – one of the biggest bubbles globally – and they have mostly worked off the savings and cash balances that many were able to build up from financial support during the pandemic. Increases in mortgage rates will lead to some drop in house prices – which is already evident, eating away at the equity home owners believed they had accumulated in their homes. And if these households start to have difficulty servicing their mortgages, the risk is that these delinquencies encourage the banks to begin to call in the loans, in some cases forcing sales at reduced prices, perhaps with bankruptcies to follow.

Even though the “Labor can’t manage money” scare campaign didn’t deliver the Coalition a victory this time, the incoming Albanese government will have to endure the failings of the economic management of its predecessor. Given the absence of an energy policy, the bursting of the household debt bubble, the tax increases and various other hits to the costs of living, we can look forward to the mother of all scare campaigns from a disappointingly unchanged Liberal–National opposition the next time around. This “inevitable mess” was undeniably inherited. 

This article was first published in the print edition of The Saturday Paper on June 4, 2022 as "Too Lowe, too long".

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