RBA Rate Hike Reignites Debate on Government Spending and Inflation

The Reserve Bank of Australia (RBA) recently increased its interest rate, citing a resurgence in inflation pressures and higher-than-expected private sector spending. This decision has intensified discussions regarding the federal government's fiscal policy and its role in managing economic demand and inflation, prompting a review of existing programs and consideration of future economic reforms.

RBA Decision and Inflation Drivers

The RBA's recent interest rate hike saw rates increase from 3.6% to 3.85%, marking a reversal of earlier rate cuts made in February, May, and August of the preceding year. RBA Governor Michele Bullock attributed the decision to several factors, including low unemployment, rising real incomes, past interest rate reductions, tax cuts, and government expenditure.

Ms. Bullock affirmed that government spending contributes to aggregate demand, which is currently slightly exceeding aggregate supply. She also noted that private demand had "strengthened substantially more than expected." The RBA's stated objective is to return inflation to its target band while maintaining a strong employment market. Some economists have noted the short timeframe between the RBA's previous rate cuts and the subsequent hike.

Government Response to Inflationary Pressures

Treasurer Jim Chalmers stated that he should not be solely blamed for the interest rate increase, emphasizing that the private sector is currently the primary driver of economic activity. He also stated that the government is not responsible for the resurgence of inflation and that public demand growth has decreased.

Mr. Chalmers acknowledged the government's role in addressing inflation and denied suggestions that the government contested public demand as a component of aggregate demand. He noted that the RBA's decision statement did not explicitly mention government spending. Both Chalmers and Ms. Bullock recognize that government fiscal policy and the RBA's monetary policy have distinct but related objectives. Ms. Bullock denied feeling any political pressure regarding government spending, stating the RBA's focus remains solely on achieving its inflation and employment targets.

Federal Budget Under Scrutiny

The Albanese government has characterized its budgets as "responsible" and "restrained," achieving surpluses in two of its first three years primarily due to higher tax collections rather than policy-driven savings. However, new policy decisions since the government took office have collectively added over $100 billion to the budget. Some economists and the federal opposition suggest that these figures challenge claims of restraint and argue that lower government spending might have resulted in lower interest rates.

Specific policies intended as cost-of-living relief have been identified by economists as potentially contributing to inflation, including widely available supports such as tax cuts and childcare subsidies. Examples cited include:

• The Electric Vehicle (EV) tax discount, with projected costs increasing from $405 million over four years to $8.1 billion.
• A subsidy for home batteries, which surged from an initial budget of $2.3 million to $7.2 million despite reduced generosity.

Economist Chris Richardson suggested that $7 billion in government spending is comparable to a 25-basis-point interest rate increase in an economy operating at its limits.

Liberal MP Simon Kennedy raised concerns that federal government spending is projected to reach 26.9% of Gross Domestic Product (GDP) in 2025-26, a 30-year high outside of the COVID-19 pandemic period. RBA Assistant Governor Sarah Hunter clarified that state, territory, and local governments also contribute to aggregate demand. Ms. Bullock also acknowledged that government transfers provide individuals with money to spend, thereby contributing to private demand.

Future Economic Strategy and Policy Considerations

The government is preparing for its May budget and considering various policy adjustments to manage inflation and promote long-term economic growth.

Upcoming Budget Adjustments

Potential considerations include:

• Reviewing programs such as the EV tax discount, with the Energy Minister having previously hinted at a review.
• Treasurer Chalmers and Finance Minister Katy Gallagher instructed public service departments to identify 5 percent of their budgets as "low priority" for potential future savings.
• Capping the growth of the National Disability Insurance Scheme (NDIS) at 6 percent annually, a reduction from a previous 8 percent target. The newly introduced Thriving Kids program aims to support this goal by focusing on early interventions for children with mild to moderate autism, potentially reducing future NDIS eligibility.

Broader Economic Vision

The government's broader economic strategy involves an expanded role in investment, employment, and production, with significant allocations to sectors such as the care economy (childcare, health, aged care, disabilities), urban and regional infrastructure, state-funded housing, industrial policy, and defence spending, alongside a transition of the energy grid towards renewables. Wages are increasing, income taxes have been adjusted, and unemployment remains near historic lows.

Tax Reform Debates

Discussions around tax reform are also underway. The Australian Council of Trade Unions (ACTU) has proposed a 25% export tax on gas, capping the fuel tax credit scheme, and reforms to negative gearing and the capital gains tax (CGT) discount. Cabinet is reportedly considering property investor incentives.

The NSW Treasury has informed a Senate inquiry that the CGT discount has exacerbated house prices, worsened affordability, and reduced home ownership, while primarily benefiting higher-income individuals and amplifying wealth inequality. This tax concession, valued at $23 billion annually, functions as an "injection" of Commonwealth funds into housing demand. Data shows investor lending increased by 1,001% to $139 billion by September last year, compared to a 50% increase in first-time buyer lending to $64 billion since the CGT discount's introduction. The Albanese government could potentially garner support from the Greens, Teals, and other independents for such changes. Mr. Chalmers has stated an ongoing ambition for tax reform.

Expert Recommendations and Urgency

Economists like Deloitte Access's Pradeep Philip suggest a future focus on improving the economy's capacity and productivity growth. Economist Chris Richardson advocated for considering more significant budgetary measures, including both tax increases and spending cuts. The Reserve Bank has reportedly downgraded its forecasts for economic growth and housing construction, indicating an urgency for policy progress.