Sky-high mortgages, 7.1% inflation, and a 20% chance of recession. How the Conversation’s panel sees the year ahead

Homeowners will face mortgage rates near 5.5% in a little over a year, according to a survey of 22 leading Australian economists.

The Conversation’s 2022-23 forecasting survey predicts an increase in the Reserve Bank’s cash rate from its present 0.85% to a peak of 3.1% by next August.

If fully passed on, the series of rate hikes would lift the cost of payments on a variable $500,000 mortgage by about $600 per month and the cost of payments on a $800,000 mortgage by about $1,000 per month.

Sydney and Melbourne home prices would slide 6-7%.

The panel believes the Reserve Bank will push its cash rate to its highest point since the 2010-2012 resources boom in an effort to contain inflation, which it expects to jump from its present 5.1% to a peak of 7.1% before the end of the year.

Panel members put the risk of an overreaction by authorities bringing on a recession at a 40% chance in the United States, and a lower 20% probability in Australia.

Now in its fourth year, The Conversation’s survey draws on the expertise of leading forecasters in 20 Australian universities and financial institutions, among them economic modellers, former Treasury, International Monetary Fund and Reserve Bank officials, and a former member of the Reserve Bank board.

Inflation

The panel expects the next inflation figure to be released later this month to show prices climbed 6.7% in the year to June – the most since the early 1990s.

Panelist Saul Eslake says it hard to be confident about when inflation will peak without being confident about when and how the conflict in Ukraine will end, although he says it is difficult to see energy prices climbing higher, and there is some evidence COVID-related supply disruptions are beginning to ease.

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On balance the panel expects inflation to peak at 7.1% towards the end of this year before declining next year.

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Interest rate rises

The panel expects the equivalent of five 0.25 point increases in the Reserve Bank’s cash rate in the next six months, and just short of another two 0.25 point increases in the six months that follow.

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On balance, the panel expects the cash rate to stop climbing when it gets to 3.1% next August, but some members expect much steeper increases.

Warwick Mckibbin, a former member of the Reserve Bank board, expects a cash rate of 4.5% (implying mortgage rates of 6.75%) by March, and he says that is less than required.

He says the cash rate needs to climb above the 3.5% that would normally be thought of as neutral, and stay there for a sustained period to bring inflation back to the Reserve Bank’s target.

Former Commonwealth Treasury and financial markets economist Warren Hogan sees rates climbing for as many as five years, although his forecast is for four.

RBC Capital Markets head of economics Su-Lin Ong believes that won’t be needed to cool the economy, as the expiry of the ultra-cheap three-year fixed rate mortgages taken out during COVID will deliver a “market-induced tightening”.

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Recession risk in the US and Australia

The panel believes the United States is at a much greater risk than Australia of a miscalculation in which rates are pushed so high to contain inflation that they bring on a recession.

The US economy has already turned down in the first three months of this year, and the panel expects it to finish the year just 2.2% larger than when the year began. The panel expects unusually low economic growth of 2.6% in China.

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In the United States, the task of defining the start and end of recessions is assigned to the National Bureau of Economic Research’s business cycle dating committee.

The panel believes there is a 40% chance it will call a recession in the next two years, with the most likely start being March 2023.

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The panel assigns a lower 20% probability to a recession in Australia (commonly defined as two consecutive quarters of negative economic growth) and believes the most likely start date is August 2023.

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Economic growth

Absent recession, the panel expects economic growth to decline in line with forecasts in the March budget from year-on-year growth of 4.25% in 2021-22 to 2.5% over the coming five years.

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Living standards

The substantial increase in wage growth the panel expects from 2.4% in the year to March to 3.6% by June next year will be nowhere near enough to prevent real wages sliding.

Even with inflation down to 4.8% by then as forecast, real wages would go backwards by a further 1.2%.

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Weighing on further increases in wages growth will be a forecast nudge up in the rate of unemployment, from 3.9% to 4.2%.

ANZ chief economist Richard Yetsenga says while reopening Australia to skilled migrants, temporary visa holders, students and backpackers will add to the supply of workers, it should also boost already very strong consumer spending, limiting any increase in unemployment.

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The panel expects outsized real growth in household spending of 4.5% in 2022-23 boosted by what Barrenjoey Capital’s chief economist Jo Masters describes as elevated household savings, combined with continuing fixed rate mortgages and the low and middle income tax offset payments due to hit accounts from July.

The broadest measure of living standards, real net disposable income per capita, should continue to advance, although modestly.

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Home prices

The panel expects mortgage rate driven falls in home prices to reach 6-7% in Sydney and Melbourne over the coming year.

Julie Toth of Swinburne University and Nous Group expects the biggest impact in low and medium income suburbs, where buyers are more vulnerable to mortgage increases.

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Markets

The panel nonetheless expects solid growth in non-mining business investment of 6.4% (and mining investment of 7.6%), and an iron ore price above US$100 an ounce but sliding down from its present US$130 to US$108.

It expects the Australian share market to end the financial year 2% lower.

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After a year in which the 10-year bond rate that determines the government’s cost of borrowing soared from 1.5% to 3.7%, panelists expect only a small further increase in 2022-23, to 3.9%.

After sliding from 75 US cents to 69 US cents, they expect the Australian dollar to climb modestly to 72 cents during 2022-23, putting some downward pressure on inflation.

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The Conversation Economic Panel

Click on economist to see full profile.

Download the 2022-23 economic survey

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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Australians are more millennial, multilingual and less religious: what the census reveals

Census data to be released Tuesday shows Australia changing rapidly before COVID, gaining an extra one million residents from overseas in the past five years, almost all of them in the three years before borders were closed.

For the first time since the question has been asked in the census, more than half of Australia’s residents (51.5%) report being either born overseas or having an overseas-born parent.

More than one quarter of the one million new arrivals have come from India or Nepal.

The census shows so-called millennials (born between 1981 and 1995) are on the cusp of displacing baby boomers as Australia’s dominant generation.

Although the number of baby boomers (born between 1946 and 1965) has changed little, as a proportion of the population boomers have fallen from 25.4% in 2011 to 21.5%. Millennials have climbed from 20.4% to level pegging at 21.5%.

The changes are reflected in the answer to the question about religion, the only non-compulsory question in the census. Almost 40% of the population identified as having no religion, up from 30% in 2016, and 22% in 2011.

Whereas 47% of millennials identify as having no religion, only 31% of boomers fail to identify with a faith. Nearly 60% of boomers are Christian, compared to 30% of millennials.

The share of the population identifying as Christian has slipped from 52% to 44%. Other religions are growing, but remain small by comparison. Hinduism climbed from 1.9% of the population in 2016 to 2.7%. Islam climbed from 2.6% to 3.2%.

The five-yearly snapshot

Conducted every five years since 1961, and before that less often from 1911, and asking questions of every Australian household, the census provides information about the ways society is changing that couldn’t be obtained in any other way.

In the past five years the number of people who use a language other than English at home has climbed 792,000 to more than 5.6 million. 852,000 Australian residents identify as not speaking English well or at all.

Mandarin remains the most common language other than English used at home, used by 685,300 people, followed by Arabic with 367,200 people.

The real value is in the detail

The real value of the census is in the locational details. The information released on Tuesday will identify locations with any characteristic that needs particular services, such as the areas with more people who identify as not speaking English well or at all. It will also show which parts of Australia are growing in population and which parts are shrinking.

The broad-brush information released on Monday showed the number of single-parent families had climbed past one million. The information released on Tuesday will identify the suburbs and towns in which they live.

The information released on Monday showed the overall proportion of Australians owning their homes was little changed. The information released on Tuesday will report those proportions by age group and city.

New questions

Two new separate questions in the 2021 census ask about service in defence forces and long-term health conditions.

One quarter of veterans are aged 65-74, reflecting conscription during the Vietnam War.

More than two million Australians suffer long-term mental health conditions; more than two million suffer arthritis; and more than two million suffer asthma.

Tuesday’s figures will offer more detail on the locations of sufferers and details such as their income and occupations, as well as details such as whether those who’ve served in defence were conscripts, serving in Vietnam.

Saved from the axe

Seven years ago the Australian Bureau of Statistics tried to axe the five-yearly census, making it 10-yearly – as in the United Kingdom and the United States – to save money.

The outcry from planners and researchers who relied on the census resulted in the bureau being given an extra A$250 million to ensure it continued.

Tuesday’s is the first of three census data releases. In October, the bureau will release information about education and employment and travel to work.

Early next year it will release location-specific socio-economic information and estimates of homelessness.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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Australia already has a UK-style windfall profits tax on gas – but we’ll give away tens of billions of dollars unless we fix it soon

The really bizarre thing about calls for a UK-style windfall profits tax on gas is that Australia’s already got one.

Gas prices have soared to levels never envisioned in the lead-up to 2015, when three resource giants spent A$80 billion building terminals in Queensland with the potential to export three times the east coast gas Australia had been using.

At the time, the “netback” international gas price (net of the cost of liquefying and shipping) was barely A$10 a gigajoule, and wasn’t expected to climb much higher.

Suddenly, in the space of a year, it has jumped to three times that level. Local industrial customers are now being asked to pay a barely-credible $382 a gigajoule – and gas suppliers were about to ask for $800, before the energy market operator stepped in and capped prices at a still “crippling” $40 a gigajoule.

Gas generators aren’t keen to power up

So expensive is gas that on Monday, when almost a quarter of Australia’s coal-fired power generating units were out of action and it looked as if NSW and Queensland would be plunged into darkness, gas generators were sitting on their hands rather than powering up.

They only acted when ordered to by the energy market operator.

In Britain, where export gas prices have climbed just as high (and one of the same companies, Shell, is involved) Prime Minister Boris Johnson has imposed a 25% windfall profits tax on oil and gas producers.

The special tax will help fund support for households struggling with high bills, and will be phased out when oil and gas prices return to normal.

Australia already has a special tax on gas

There are precedents here for singling out an entire industry for an extra tax. Scott Morrison did it in 2017 with a special tax on big banks, which continues to this day.

The Rudd and Gillard governments tried it with a short-lived 40% super-profits tax on the mining industry, which was based on … well, it was based on the longstanding 40% resource rent tax applying to the oil and gas industry.

That’s right. Australian oil and gas producers have had to shell out 40% of their profits in tax, in addition to 30% company tax on profits, for years.

That’s a total big enough to ensure the windfall profits resulting from Russia’s invasion of Ukraine are well and truly taxed along the lines announced in the UK, allowing Australia’s government to grab most of the windfall and use it to support households suffering from high energy prices. Or so you would think.

And yet the amount collected is tiny: $2.4 billion, which is no more than was collected in 2005. At times, it has fallen as low as $1 billion. In the words of the Grattan Institute’s Tony Wood, himself a former energy executive, it is a “rather strange thing to have a tax that nobody pays”.

Australian Institute analysis of Tax Office data suggests that none of the big three Queensland gas exporters has paid any income tax since their projects began in 2015, except for $3 billion paid by Santos, once, on revenue of $5.3 billion.

Designed for oil, used for gas

In 2016 Morrison commissioned retired public servant Michael Callaghan to inquire into why the minerals resource tax was raising so little money.

Callahan found it well designed for oil, which it was set up to tax in 1988, but poorly designed for gas.

One of the two biggest problems was “uplift”. Profits are taxed after deducting earlier losses. These losses are carried forward using an uplift rate.

For oil projects, the uplift rate on losses doesn’t much matter because they start making profits fairly soon.

Gas projects are much more expensive and take many more years to produce a return, making the uplift rate significant.

Australia applies two uplift rates: the long-term bond rate plus 5% (for general losses), and the long-term bond rate plus 15% (for exploration losses).

So much can the long-term bond rate plus 15% grow over time that Callaghan found it allowed exploration deductions to

almost double every four years, which means that a moderate amount of exploration expenditure can grow into a large tax shield

And firms hang on to the high-uplift deductions, using the low-uplift ones first.

The second big problem is that, whereas with oil it is easy to tell when the oil has been mined and the profit should be taxed, with integrated liquidated natural gas projects, it is hard to tell when the mining stops and the liquefaction starts.

Taxing in the dark

Without an observable final price for the gas before it is liquified, three methods are used – two of them complex and one a private agreement with the tax office.

Callaghan found that if the simpler “netback” method was used, the tax would raise an extra $89 billion between 2023 and 2050 including a “particularly strong” extra $68 billion between 2027 and 2039 at the prices then prevailing.

In his 2018 response Treasurer Josh Frydenberg cut the uplift rates and asked the treasury to review the method of calculating the transfer price. It was to report back “within 12 to 18 months”.

For all we know, the treasury did report back, perhaps two years ago in May 2020.

It’s a fair bet our new government will be keener than the old to actually raise more than a couple of billion from the petroleum resource rent tax, especially given the amount now available to tax.

If the extra tax was used to provide relief from high energy prices, Australia’s government could no more be criticised than could Boris Johnson’s in the UK.

And if it merely said it was thinking of properly applying the tax we’ve got, it might find Australia’s gas exporters suddenly more co-operative.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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Expect the RBA to go easy on interest rate hikes from now on – we can’t afford rates to climb as steeply as the market expects

By lifting its cash rate by 0.5 points, from 0.35% to 0.85%, the Reserve Bank has added about another $120 per month in payments for a A$500,000 mortgage.

If financial markets are to be believed, by the end of this year it will have added a total of $800 per month – and, by the end of next year, a total approaching $1,000 per month.

Those figures are for variable mortgages, but homeowners on fixed rates won’t escape them long. Those rates are typically fixed for up to three years.

Many of the fixed-rate mortgages were taken out during COVID at annual rates as low as 2%. When those fixed rates end (and many will end in the next year or so) those homeowners will find themselves paying 5% or 6% per year, shelling out as much as $3,000 per month instead of $2,000.

Unless financial markets are wrong. The good news is, I think they are.

The pricing of deals on the futures market factors in an increase in the Reserve Bank’s cash rate from 0.10% to 3.5% by June next year, enough to push up the standard variable mortgage rate from around 2.25% to 5.65%.

We couldn’t afford the rates the market expects

One reason for suspecting it won’t happen is that many homeowners simply couldn’t afford the extra $1,000 per month. Most of us don’t have that much cash lying around.

US President Richard Nixon had an economic adviser by the name of Herbert Stein with an uncommonly-developed sense of common sense. In his later years he wrote an advice column for Slate magazine.

To a reader wanting a cure for unrequited love, he wrote that the best solution was “requited love”. To a reader concerned about her inability to make small talk, he wrote that what people want most is a “good listener”.

In economics, Stein is best known for Stein’s Law, which says: “if something cannot go on forever, it will stop”.

Mortgage rates can’t keep climbing to the point where homeowners pay an extra $1,000 per month.

For new homeowners, it’s worse. The typical new mortgage taken out to buy a home in NSW has climbed to $700,000. In Victoria, it has climbed to $585,000. These people will be paying a good deal more than an extra $1,000 per month if the bets on repeated rate hikes made on the futures market come to pass.

The Reserve Bank says it lifted its cash rate from 0.35% to 0.85% today to withdraw the “extraordinary monetary support” put in place during the pandemic.

But the bank says from here on it will be guided by data, and, in a nod to homeowners concerned about continual rate hikes, said it expected inflation to climb just a bit more before declining back towards its target next year.

The bank will be guided by data

Financial markets don’t see it that way. They have priced in (in other words, bet money on) rate hikes in July, August, September, October, November, December, February, March, April and May.

But there are reasons to believe the bank is right about inflation.

It doesn’t seem that way with electricity prices set to climb 8-18% in NSW, 11% in Queensland, 5% in Victoria, and as much as 20% in South Australia. (The only jurisdiction without an increase in prospect is the Australian Capital Territory, which has 100% renewables and fixed long-term contracts.)

Fortunately for overall inflation, electricity accounts for less than 3% of the typical household budget. Gas accounts for less than 1%. Even low earners spend little more than 4% of their income on electricity.

While the price of vegetables is soaring (heads of lettuce are selling for $10), we spend less than 1.5% of our income on vegetables.

The best measure of overall price increases remains the official one of 5.1% for the year to March, calculated by the Bureau of Statistics.

It is a more alarming increase in inflation than Australians are used to. But what matters for the Reserve Bank is whether the 5.1% is set to turn down and head back towards the target of 2-3%, or climb further away from it.

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Australia is almost uniquely disadvantaged among developed nations in getting a handle on what’s happening to inflation, being one of only two OECD members (the other is New Zealand) to compile its consumer price index quarterly, instead of monthly.

By the time Australia’s index is published, several of the measures in it are months old, and they don’t get updated for another three months.

It has been said to make the bank’s job like driving a car looking through the rear-view mirror.

Using our rear-view mirror, with caution

Fortunately the Bureau of Statistics is gearing up to produce a monthly index. Meanwhile, in the United States – which is subject to the same international price pressures as Australia – most measures of inflation eased in April.

Wages growth, which the Reserve Bank said last month seemed to be “picking up”, remained dismal in the figures released a few weeks later – at just 2.4% in the year to March. That was well short of the 2.7% forecast in the budget for the year to June, and not enough to do anything to further fuel inflation.

Australia has a history of aggressive interest rate hikes to tame inflation.

In 1994, Reserve Bank Governor Bernie Fraser rammed up the cash rate from 4.75% to 7.5% in a matter of months. But that was when wage growth was well above inflation and the bank was trying to dampen “demands for wage increases” to prevent a wage-price spiral.

We don’t even have the beginnings of that yet. Unless the bank wants to needlessly impoverish Australians, and keep going until it pushes them out of work, it will increase rates cautiously from here on.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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Australia’s biggest economic threat isn’t home-grown. It’s a recession, originating in the United States

A recession in the US usually brings on a recession in the rest of the world, although not always in Australia.

Australia has escaped such a recession twice in the past 50 years.

We avoided the early-2000s so-called tech-wreck recession, and we avoided the so-called “great recession” during the global financial crisis.

Amid ominous talk about yet another US-led global recession, there’s a chance we could escape for a third time.

But it will require being prepared to change our budget and interest settings in a heartbeat. That’s something our new treasurer Jim Chalmers – who many don’t realise was an advisor to the treasurer during the global financial crisis – knows a good deal about.

The hunt for savings, now and then

Right now, Chalmers and finance minister Katy Gallagher say they are going line by line through the budget to look for waste and rorts. They’ll find a lot.

That’s how it was 15 years ago for another new treasurer, Wayne Swan, and his finance minister Lindsay Tanner.

Swept into office with Prime Minister Kevin Rudd in 2007, in an election marked by plummeting unemployment, a mid-campaign interest rate hike, and growing inflation, they identified A$3 billion they could cut without blinking.

It was, said Tanner, “just for starters”.

Cuts are easy – at first

Incoming governments can always find savings because their priorities are different, and because the outgoing government has grown used to spending big.

Desperate to stay in office, the Howard government shovelled $500 cheques to senior citizens on its way out. The Morrison government handed them $250 cheques, dressed up as cost of living payments.

Chalmers and Gallagher say they’ll save $350 million instantly by removing funds from the Coalition’s marginal-seat-focused community development program, and millions more by axing the $500 million regionalisation fund announced in the March budget before it gets started.

But circumstances can change

But even before Swan and Tanner had handed down their first budget in 2008, they were confronted by realities that made them wince.

As Swan tells it, he took a call at 6.30am, while sheltering in his car from bucketing rain near a beach on Queensland’s Sunshine Coast, from US Treasury Secretary Hank Paulson.

It was January 10 2008, one year into the US sub-prime mortgage crisis. Fifty US mortgage companies had declared bankruptcy. Paulson had asked for the call.

As Swan remembers it, Paulson told him:

Look, if we can avoid a meltdown in house prices, then we might be able to see a way through this.

That was a very big “if”, Swan thought, later writing he suspected the aside might be the real reason for the call.

“It seemed a dicey prospect that the health of the entire US economic system was underpinned by the housing market stabilising,” Swan wrote. What if the US housing market didn’t recover?

Swan sought advice from Australia’s treasury, which warned him the risks to the global economy from the US housing market were “substantial”.

From that day on, Swan performed a balancing act – as Chalmers, then the treasurer’s advisor, later wrote.

On one hand, Australia was facing accelerating inflation, which would necessitate higher interest rates and “savage across-the-board” spending cuts.

On the other hand, by the end of the 18 months it would take for those spending cuts to really hurt, the world might be in crisis.

Swan withdrew the harshest cuts, warned in his budget speech about “economic turbulence” and looked on in dread as the Wall Street giant Lehman Brothers collapsed and the globe slid into recession.

A US recession is entirely possible

Fast forward to 2022, and the US economy was once again in trouble, even before Russia invaded Ukraine on February 24.

Inflation had climbed above 7% for the first time since the 1979 oil crisis. It is now above 8% and the US Federal Reserve is ramping up interest rates in an increasingly desperate attempt to contain it.

The world’s leading economic journalist, Martin Wolf, believes it won’t be able to do it without bringing on a recession.

If the entire United States can be made to spend less, it will indeed restrain global prices. (This isn’t true for Australia, which has too few people to affect the global price of commodities such as oil.)

But it is enormously hard to get right; all the more so if Americans decide to spend the savings they’ve built up during COVID.

Wolf says the Federal Reserve has to run the risk of recession in order to tame inflation. It has to “screw up its courage and do what it takes”.

Treasury is on to it

Chalmers and his officials are attuned to what’s happening overseas.

There’s speculation China’s zero-COVID lockdowns are sending its economy backwards – though there’s also speculation that, even if that’s happening, it’s unlikely to be reflected in China’s official figures.

After briefings with treasury officials, Chalmers warned last week that while commodity prices have been stronger than expected, there was no guarantee that would remain the case by the October budget.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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Lifting the minimum wage isn’t reckless – it’s what low earners need

Stand by for something “reckless and dangerous”.

That’s what former prime minister Scott Morrison said Prime Minister Anthony Albanese would be if he asked the Fair Work Commission to grant a wage rise big enough to cover inflation. It would make Albanese a “loose unit” on the economy.

Yet Albanese and his industrial relations spokesman Tony Burke are preparing to do just that ahead of the commission’s deadline of June 7, in time for the increase to take effect on July 1.

The increase would amount to a dollar an hour, lifting Australia’s minimum wage from A$20.33 an hour to A$21.36. New Zealand has just lifted its minimum from NZ$20.00 to NZ$21.20.

Despite what Morrison and his team said about in the campaign about previous governments avoiding recommending specific recommendations, Morrison’s predecessors Fraser, Hawke and Howard did it for years, and state governments are still doing it.

Back in March, when Australia’s official inflation rate was 3.5%, before it had climbed to 5.1%, Victoria recommended 3.5%.

And the government of which Morrison was a part wasn’t shy about telling employers what to pay.

In 2014 its employment minister Eric Abetz counselled “weak-kneed” employers against “caving in” to union demands, setting off a “wages explosion”.

Of course, there’s no guarantee that the Fair Work Commission will heed the new government’s push for a $1 an hour increase.

The commission is perfectly capable of determining what wage rises to grant, after taking into account all submissions. In all but one of the past ten years it has granted more than the prevailing rate of inflation at the time.

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Whether it will do that again remains to be seen next month. But to get ahead of that announcement, here’s how the commission explained its thinking in its most recent decision in June last year.

Most workers aren’t on awards

In ruling on a minimum wage increase, what matters most to the commission is employers’ ability to pay (the profits share of national income had climbed during five years in which the wages share had shrunk) and the living standards of Australia’s lowest paid.

Only the lowest paid 2% of workers get the national minimum wage, and a further 23% get the minimum award rates the commission adjusts at the same time.

Last year, the commission found some households on the minimum wage had disposable incomes below the poverty line, and it was reluctant to see them fall further.

It was also reluctant to grant a flat dollar increase that would boost the position of low earners relative to higher earners, saying past flat dollar increases “compressed award relativities and reduced the gains from skill acquisition”.

A percentage rather than a flat increase would particularly benefit women, because, at higher levels, women were “substantially more likely than men to be paid the minimum award rate” and less likely to be paid via contract or an enterprise bargain.

In deciding what percentage increase to award, it gave considerable weight to the most recent increase in the consumer price index (CPI). Right now, that’s 5.1%.

The Commission dismissed suggestions, put forward again in the context of the latest 5.1% increase in the CPI, that it should use the separately calculated “employee living cost” index, which has come in at 3.8%.

The employee living cost index has been climbing by less than the CPI because it includes mortgage rates, which have been falling, whereas the CPI does not.

Low earners aren’t mortgagees

The commission made the point that low-paid workers were less likely to own a home than higher-paid workers, making the CPI a better measure for them.

But not a perfect measure. The Australian Bureau of Statistics has begun dividing the CPI into “discretionary” (non-essential) purchases and other, essential, purchases.

The commission says low income households spend more of their income on essentials than higher earning households, making “non-discretionary” inflation especially relevant. Non-discretionary inflation is running at 6.6%.

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The commission rejected suggestions the increase it proposed could push Australians out of work or make it harder for young Australians to find work.

Which isn’t to say that couldn’t happen. During the 1970s and 1980s high wage growth fed both high inflation and high unemployment, so-called stagflation.

Wages aren’t destroying jobs

But back in the 1970s and 1980s, wages were climbing faster than the combination of price growth and productivity growth, making increases hard for employers to pay. Of late, the profits share of national income has been climbing rather than falling, giving employers an increasing ability to pay.

And whereas back then most workers were paid via the awards set by the commission, today most are paid via enterprise agreements negotiated firm by firm, meaning increases in awards only flow through to workers on agreements to the extent that they and employers are able to agree on them.

And what the government is proposing is not an increase markedly greater than inflation, of the kind that fed stagflation though the 1970s and early 1980s, but an increase in line with prices – even though employers might be able to pay more.

If what the government is proposing strikes the commission as reckless or dangerous, it will reject it. The increases it has granted to date have added to neither unemployment nor (particularly) to overall wages growth.

Low earners versus homeowners

The commission will certainly reject any suggestion that it ignore the next increase in compulsory superannuation contributions, due to lift employers’ contributions from 10% of salary to 10.5% in July.

The contributions are a cost to employers and a benefit to employees. It has taken them into account in the past.

And it should reject, as repugnant, Morrison’s suggestion that it should clamp down on wage rises for Australia’s least paid, so homeowners can continue to enjoy historically unprecedented low mortgage rates.

Homeowners, almost all of them, are much better off than Australia’s least paid.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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Elections used to be about costings. Here’s what changed

The last week of campaigns used to be frantic, behind the scenes. In public, right up until the final week, the leaders would make all sorts of promises, many of them expensive, with nary a mention of the spending cuts or tax increases that would be needed to pay for them.

Then, in a ritual as Australian as the stump jump plough, days before the vote the leaders’ treasury spokesman would quietly release pages and pages of costings detailing “savings”, which (astoundingly) almost exactly covered what they were spending, meaning they could declare their promises “fully funded”.

It was a trap for oppositions. Whereas governments seeking reelection could have their savings costed by the enormously-well-resourced departments of treasury and finance before campaigns began, oppositions were forced to rely on little-known accounting firms with little background in government budgeting.

The errors, usually not discovered until after people voted, were humiliating.

Costings time was danger time

In 2010, a treasury analysis of the opposition costings prepared by the Coalition’s treasury spokesman Joe Hockey and finance spokesman Andrew Robb found errors including double counting, booking the gains from a privatisation without booking the dividends that would be lost, and purporting to save money by changing a budget convention.

The Gillard government evened the playing field in 2011 by setting up an independent Parliamentary Budget Office to provide oppositions with the same sort of high-quality advice governments got, helping ensure they didn’t make mistakes, and enabling them to publish the advice in the event of disputes.

Ahead of the 2019 election the PBO processed 3,000 requests, most them confidential.

This means you should take with a grain of salt Treasurer Josh Frydneberg’s assertion that Labor has “not put forward one policy for independent costing by treasury or finance” – these days opposition costings are done by the PBO.

But the PBO didn’t end the costings ritual. In fact, it institutionalised it.

The ritual derives from the days when, on taking office, new governments proclaimed themselves alarmed, even shocked, at the size of the deficits they inherited. From Fraser to Hawke to Howard, they used the state of the books they had just seen to justify ditching promises they had just made.

The Charter of Budget Honesty improved things

Howard applied a sort-of science to it, memorably dividing promises into “core” and, by implication, “non-core” in deciding which to ditch.

Then that game stopped. Since 1998, Howard’s Charter of Budget Honesty has required the treasury and department of finance to publicly reveal the state of the books before each election, making “surprise” impractical.

But the legislation that set up the Parliamentary Budget Office entrenched the costings ritual by requiring each major party to hand it a list of its publicly announced policies by 5pm on election eve, in order for the PBO to publish an enduring account of their projected impact on the budget.

Which is why the parties have remained keen to get in early and find savings.

Sometimes, savings backfire

In 2016 this led to a human and financial tragedy. Three days before the election Treasurer Scott Morrison announced what came to be called “Robodebt” as part of a savings package designed to to offset spending. It was to save $2 billion.

Five years later in the Federal Court, Justice Bernard Murphy approved the payment of $1.7 billion to 443,000 people he said had been wrongly branded “welfare cheats”, ending what he called a “shameful chapter” in Australia’s history.

The costings document the Coalition released on Tuesday is less dramatic.

It says it will offset $2.3 billion in new spending over four years with a $2.7 billion boost in the efficiency dividend it imposes on departments to restrain spending.

Labor abandons the game

Labor will release its costings on Thursday, and here’s what’s changed. It says it won’t offset its spending.

Shadow Treasurer Jim Chalmers wants to be judged not on the size of spending, but on what the spending is for.

The most important thing here is not whether deficits are a couple of billion dollars each year better or worse than what the government is proposing. What matters most is the quality of the investments.

He points to the hundreds of millions borrowed to support the economy during the pandemic, the $20 billion he says was spent on companies that didn’t need it, and the $5.5 billion spent on French submarines that now won’t be built.

In sporting parlance, Chalmers has walked away from the field.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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Stand by for the oddly designed Stage 3 tax cut that will send middle earners backwards and give high earners thousands

The Reserve Bank is pushing up interest rates to take money out of our hands.

The first increase in the current round will add about A$65 a month to the cost of paying off a $500,000 mortgage.

The second will add a bit more. If, as the bank’s forecasts assume, there are another four such increases this year, that’s a further $275 a month, and so on.

The point, in the words of the Reserve Bank Governor Philip Lowe, is to “slow the economy, to get things back onto an even keel”.

In a helpful video, the Governor explains that rate rises take money out of mortgagee’s hands directly, make it harder to borrow, make people “feel less happy”, and hit the prices of houses and other assets so people “don’t feel as confident and they don’t spend as much”.

Which is fair enough, if the Governor decides that’s what’s needed.

So why on earth are we scheduled to do the opposite?

As the RBA takes, the government will give

From mid-2024 the government will put an awful lot of money in to people’s hands. Stage 3 of the income tax cuts will cost $15.7 billion in its first year.

By way of comparison, that’s almost as much as the $16.3 billion will be spent on the Pharmaceutical Benefits Scheme that year, and more than the $10.5 billion that will be spent on higher education.

That it is mistimed ought not be a surprise. Stage 3 was legislated in 2018.

The treasurer at the time, back in the year Grant Denyer won the Gold Logie, was Scott Morrison, who said he was legislating Stages 1, 2 and 3 of the tax cuts all at once (and Stage 3 six years ahead of time) in order to provide “certainty”.

A tax switch settled years ahead of time

So uncertain was the treasury about the future back then that it only forecast the economy two years ahead, and produced less reliable and more mechanical “projections” for the following two years, neither of which extended to 2024.

At the time the Reserve Bank had been cutting interest rates (12 times in a row), at the time inflation was 1.9%. It looked as if the economy could do with a bit of a boost, albeit a boost which wouldn’t be delivered for six years.

In saying that things have changed, it’s fair to also acknowledge that things might change back again. We can’t be sure what will be needed in 2024, although we can be a good deal more sure than we were back then.

Backed by Labor

The Stage 3 tax cuts were opposed by Labor at first, but are now backed by Labor treasury spokesman Jim Chalmers after “weighing up a whole range of considerations”.

They are overwhelmingly directed at high earners.

Of the $184.2 billion the parliamentary budget office believes Stage 3 will cost in its first seven years, $137.9 billion is directed to Australians on $120,000 or more.

Part of Stage 3, the part that cuts the rate applying to incomes over $45,000 from 32.5 cents in the dollar to 30 cents, will benefit most taxpayers.

The bigger part extends that low rate all the way up to $200,000, abolishing an entire rung of the tax ladder paid by the highest earners.

For those very high earners, the part of their income that was taxed at 37 cents will be taxed at 30, as will part of the rest that was taxed at 45 cents.

A politician, on a base salary of $211,250, will get a tax cut of $9,075. A registered nurse on $72,235 will get a tax cut of $681 according to calculations prepared by the Australia Institute.

More broadly, a typical middle earner can expect $250 a year, whereas a typical earner in the top fifth can expect $4,230 according to a separate analysis by the parliamentary budget office.

The fate of the middle earner will be made worse by the loss of the $1,000+ middle income tax offset which wasn’t extended in this year’s budget, sending the middle earner backwards.

The typical female earner will go backwards too after the loss of the offset, getting half as much as the typical (higher earning) male, according to the budget office.

A tax switch that’ll send some backwards

The logic is (or was) that middle and higher earners would need big tax cuts to compensate them for bracket creep (which is wage rises pushing them into higher tax brackets), though there’s been a lot less of that than expected.

Were it not for the fact that Labor supports and will implement it, Stage 3 would provide a stark contrast with Labor leader Anthony Albanese’s approach unveiled on Tuesday of asking the Fair Work Commission to lift the minimum wage to compensate for inflation.

Such an increase would go to low wage earners first, and flow through more slowly to award wages. It would give the greatest help to those who needed it the most when they needed it, rather than years in the future when things might be quite different.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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Why the RBA should go easy on interest rate hikes: inflation may already be retreating and going too hard risks a recession

One of the stranger things about the Reserve Bank’s announcement of why it’s lifting interest rates by 0.25 percentage points is that it suggests inflation will come down by itself.

“A further rise in inflation is expected in the near term,” the RBA says, “but as supply-side disruptions are resolved, inflation is expected to decline back towards the target range of 2-3%.

So why raise rates now, for the first time in more than a decade? The bank says it is about "withdrawing some of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic”, which is fair enough.

But our latest burst of inflation is weird, and resistant to rate hikes. If the Reserve Bank isn’t careful, too many more rate hikes like this might help bring on a recession.

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Labor’s Anthony Albanese is as good as correct when he says “everything is going up except your wages” – not completely correct, because wages are going up, by a minuscule 2.3% per year on the official figures; but essentially correct, because when it comes to prices, almost every single one is going up.

Every three months the Bureau of Statistics prices around 100,000 goods and services. They account for almost everything we buy, the exceptions including illegal drugs and prostitution, where pricing would be “difficult and dangerous”.

Among the types of bread the bureau prices are rye, sliced white, and multigrain, from all sorts of stores in every capital city. Where the bureau doesn’t price a type of loaf, it is a fair bet its price moves in line with the loaves it does price.

Then it groups these 100,000 or so prices into “expenditure classes”, 87 of them. “Bread” is one, “breakfast cereals” is another. Furniture and rent are two others.

Rarely do the expenditure classes move as one. Typically, only 50 or so of the 87 climb in price. But in the March quarter just finished, an astounding 70 climbed in price; according to Deutsche Bank economist Phil O'Donaghoe, that’s the most ever in the 72-year history of the consumer price index.

And the prices that climbed most – by far – were the ones we had little choice but to pay.

Necessities up, treats not as much

The bureau divides the 87 classes of goods into “non-discretionary” and “discretionary”.

It classifies bread as non-discretionary, biscuits as discretionary; petrol as non-discretionary, new cars as discretionary, and so on.

In the year to March, non-discretionary inflation (the price rises we can’t avoid) was a gargantuan 6.6% – well above the official inflation rate of 5.1%, and the highest in records going back to 2006.

Discretionary inflation – the price rises on the treats we splurge on if we’ve got the money – was only 2.7%.

Not since 2011 has the gap been that wide, which makes this inflation unusual.

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While price rises are extraordinarily widespread – because most things need diesel to move them, and we were hit with floods, COVID-linked supply problems and the invasion of Ukraine all at once – they don’t seem to be the result of splurging.

These price rises are more like a tax.

The usual response to the usual hike in inflation is to hike interest rates. It’s a way to take away access to cash and push up mortgage and other payments so people have less money to spend and push up prices.

But this hike in inflation is doing that by itself, as the government recognised in the budget by handing out $250 cash payments to compensate.

These price rises are like a tax

If the big price rises are beyond our control and making us poorer, hiking interest rates to make us poorer still, in the hope we will splurge less on things whose prices we can influence (and whose price rises are small) might not achieve much.

Done repeatedly, the Reserve Bank could push up interest rates because inflation is high, discover inflation is still high, push interest rates higher in response, notice inflation is still high, push interest rates even higher in response… and so on, until it had brought on a recession.

A recession is already a risk with these sorts of price rises. If big enough, they can force consumers to cut other spending to the point where the economy stagnates and creates unemployment in the face of inflation – so-called “stagflation”.

Another response would have been to wait. Seriously. The floods, invasion and supply problems pushing up prices in recent months are likely to pass, pushing down inflation and pushing down a lot of prices.

Inflation might have already fallen

It might have already happened. The oil price has fallen 11% from its peak, down 2.5% in the past two weeks alone. And inflation has fallen – on one measure, to zero.

The official Bureau of Statistics measure of inflation is produced every three months, but for 13 years now the Melbourne Institute of Applied Economic and Social Research has produced its own simpler monthly measure, which tracks the official rate pretty well.

Although missing a lot (tracking fewer types of bread, and a national rather than a city-by-city measure) it is produced quickly and more often, providing a better insight into prices in real time.

The latest, released on Monday, points to an inflation rate of zero in April.

That’s right. While some prices continued to rise as always, enough prices fell to offset that. The high inflation in the lead-up to March stopped or paused in April.

Rate hikes need only be mild

It’s different in the United States. There, inflation is supercharged by wage growth averaging 9% and the Federal Reserve is about to lift interest rates aggressively.

Here, wage growth in the year to December was just 2.3%. We’ll get the figures for the year to March in a fortnight. There’s a good case for future rate hikes to be a good deal less aggressive.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

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The 4 economic wildcards between now and election day

There are four economic wildcards between now and the election, and we know exactly when each will be played.

The first is this Wednesday at 11.30am eastern time, when we get the official update on inflation. We’re likely to see a figure so large it will take many of us back to the 1990s, to a time before anyone under 30 was born.

With the exception of a short-lived blip following the introduction of the goods and services tax in 2000, inflation has scarcely been above 5% since 1990.

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After a series of extremely large interest rate hikes in the early 1990s succeeded in taming inflation, it has been close to the Reserve Bank target of 2-3% ever since – so much so that even those of us who remember the 8% inflation of the 1980s and the 18% in the 1970s have come to regard fairly steady prices as normal.

When ABC Vote Compass asked voters to name the issue of most concern to them in the 2016 election, only 3% picked “cost of living”.

Only 4% picked “cost of living” in 2019. With inflation so low it had dropped below the Reserve Bank target band, and a good deal below slow-growing wages, there was nothing much to be concerned about.

Suddenly, the cost of living matters

That was until the last few months. Suddenly, the latest Vote Compass finds “cost of living” is voters’ second biggest concern, behind only climate change.

This election, 13% of voters – one in eight – regard the cost of living as the most important concern of the lot, ahead of accountability, defence, health, education and COVID.

It has happened because prices are climbing like they haven’t in years. The official inflation rate for December (the most recent we’ve got) had prices climbing at an annual rate of 3.5%.

Led by petrol and food, they climbed an awful lot more in the lead-up to March, with the figures to be released on Wednesday likely to show annual inflation approaching 5%.

While that’s some way short of the 6.7% inflation in Canada, the 6.9% in New Zealand, the 7% in the United Kingdom, and the 8.5% in the United States, each of these countries has begun increasing interest rates as a result, some quite aggressively.

A high inflation rate on Wednesday will confirm what the public suspects: that prices really are climbing at a pace without modern precedent, and that for those who rely on wages, it is sending their living standards backwards.

It will also encourage the Reserve Bank to begin to push up interest rates in line with its contemporaries throughout the English-speaking world, eating into the living standards of Australians on mortgages.

The second wildcard: rising interest rates

That’s when the second election wildcard gets played, next Tuesday May 3, at 2.30pm eastern time, after the Reserve Bank board’s May meeting.

If inflation is especially high, there’s a chance the bank will announce it is pushing up rates, lifting its cash rate from its present all-time low of 0.10% to 0.25% or to 0.50%, and holding an afternoon press conference to explain why.

If fully passed on, an increase to 0.50% would add an extra $100 to the monthly cost of paying off a $500,000 mortgage.

The increase, and the explanation that it was much higher prices that brought it about, would be crushing for a government campaigning on what it is doing to address the cost of living. It would help Labor, which has made the cost of living a key plank of its campaign.

There ought to be no doubt that if the bank decides it needs to raise rates at its meeting next Tuesday, it will do it then, rather than wait a month until the campaign is over. It pushed up rates during the 2007 campaign, three weeks before John Howard was swept from power.

But if inflation isn’t ultra-high but merely high, and not necessarily sustainably high, the bank is likely to wait for another piece of evidence before acting.

After its last meeting it said it wouldn’t lift rates until it saw “actual evidence” that inflation was “sustainably” within the 2-3% target range.

The wages wildcard – 3 days before polling day

To get that evidence, the board would need either very high inflation, or evidence that wage growth was high enough to sustain what might otherwise be short-lived high inflation, caused by a spike in the oil price (which has since retreated 16%).

That official word on wages is the third economic wildcard, arriving at 11.30am eastern time on Wednesday May 18, three days before voting day.

To date wage growth has been frustratingly low: at 2.3% in the year to December, well below what is needed to maintain living standards in the face of inflation, and well below what would normally be needed to make high inflation self-sustaining.

High official wage growth in the year to March could make a post-election interest rate hike all but certain, if rates haven’t already gone up ahead of the election.

Continued demonstrably weak wage growth – which is probably more likely – will officially confirm that prices are racing ahead of wages, just before polling day.

The poll-eve jobs wildcard

Which leads on to the fourth economic wildcard, to be delivered the next day, two days before polling day on Thursday May 19 – about the only piece of economic news ahead that’s likely to play well for the government.

Ultra-low interest rates and massive government stimulus, originally designed to keep people in jobs during COVID but continued beyond that, have delivered an unemployment rate that rounds to 4% but is actually a touch below it at 3.95%, the lowest since November 1974, almost 50 years ago.

There’s every chance the April unemployment rate will be even lower, perhaps the 3.75% the treasury expects later in the year. If it is, the Coalition will deserve and will claim a lot of the credit. Labor will be left to talk about the cost of living.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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This model tipped the last 2 elections. It’s pointing to a Coalition win

This election will be won by the Coalition and Prime Minister Scott Morrison if the economic models perform as expected – and they usually do.

A model refined in 2000 by then Melbourne University economists Lisa Cameron and Mark Crosby found that most federal election results in records going back to 1901 can be predicted pretty well by just two economic indicators.

And they are not the indicators that might be expected.

The growth in real wages in the year leading up to the election appears to have no effect on the governing party’s chance of being returned to power. (Which is just as well for the Coalition, because the buying power of wages has been shrinking.)

Similarly, GDP (which is shorthand for gross domestic product, the measure meant to encompass almost everything known about the state of the economy) turns out to be “not robustly correlated” with support for the incumbent government in Australia, although it is in the United States.

The only two economic variables that do matter, and they seem to matter a lot, are the rate of inflation and the rate of unemployment, each in a different way.

For inflation, the higher it is, the more the incumbent suffers, as you might expect.

For unemployment, what turns out to matter is not the rate itself. High rates and low rates appear not to be sheeted home to the party in power. What is sheeted home, big time, is the change in the rate.

Voters reward lower unemployment

A government seen to have cut the unemployment rate gets rewarded, while a government seen to have pushed up the rate gets punished.

Cameron and Crosby find a one percentage point increase in the unemployment rate cuts a government’s vote share by 0.58 percentage points.

And they find a wrinkle. In swinging seats, Coalition governments are likely to be punished if unemployment rises, whereas Labor governments are likely to be rewarded. They say their findings are “consistent with voters having the perception that the Labor party is more committed to lowering unemployment”.

In 2005 economists Andrew Leigh (the one who later became a Labor politician) and Justin Wolfers applied a slightly different model to the 2004 election. They found it got the result right, but under-predicted the size of the Coalition victory.

The model usually gets it right

In the latest edition of the Australian Economic Review, University of Queensland economist Hamish Greenop-Roberts applied the Cameron and Crosby model to the past four elections, the one Labor won in 2010 and the ones the Coalition won in 2013, 2016 and 2019. He found it picked the result three times out of four, putting it on a par with the polls and betting odds, which also got the result right three times out of four.

The crucial difference is the economic model got the results right in each of the past two elections – something the others conspicuously failed to do.

Asked this week what the economic model would predict for the current election, Greenop-Roberts notes that on one hand, unemployment is much lower than it was at start of this government’s term (and far lower than was expected), which the model says should help it get re-elected.

On the other hand, inflation is unusually high, which the model says would hurt.

What matters for predicting the outcome is the size of each move and how much the size of each move has turned out to matter in the past.

And it’s no contest. The effect of the dramatic cut in the unemployment rate (from 5.2% to 4%) is so big it more than outweighs the effect of the 3.5% rate of inflation, “setting the stage for the Coalition to be returned”.

Unemployment trumps inflation

So big is what has happened to unemployment that Greenop-Roberts says an inflation rate of at least 8% to 9% would be required to flip the prediction.

Whatever Australia’s official inflation rate is in the lead-up to polling day (there will be an update next Wednesday) it will very possibly above its present 3.5% but still be way short of 8-9%.

Or perhaps the model will be wrong when it comes to inflation. Greenop-Roberts points out that since the early 1990s, an entire generation of voters has entered adult life without experiencing serious inflation, and might either be alarmed by it or not understand the concept. This election might provide a test.

And it is possible this will be one of the rare elections in which the state of the economy fails to predict the outcome. Opinion polls did badly in the last election, but they might recover and they are suggesting a Labor victory. Betting markets did badly too, and are only just suggesting a Labor victory.

Polls, experts and even the model can be wrong

Experts often get it wrong. Greenop-Roberts points to a poll of 13 experts published two days before the 2019 election.

Twelve predicted a Labor victory. The only expert who didn’t predicted the Coalition would be forced to govern jointly with independents, a prediction some way short of the result, which was a comprehensive Coalition victory.

The reality is that this election will be fought seat by seat, and Greenop-Roberts has identified a new metric that might help predict those outcomes.

His Australian Economic Review paper compares the electorate by electorate results of the 2017 same-sex marriage poll with the electorate by electorate swing to the Coalition in 2019.

He finds the electorates that swung most to the Coalition in 2019 (shown below) were those most opposed to same-sex marriage.

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‘No’ vote in the 2016 same sex marraige poll versus 2019 swing to Coalition

Forecasting Federal Elections: New Data From 2010–2019 and a Discussion of Alternative Methods, Hamish Greenop-Roberts

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The statistically significant link better predicted voting intention than income, education or unemployment.

It might again, or we might not yet have perfected the science of predicting what will happen, which might be just as well. What’ll happen in this election is up to all of us.

Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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