The Stats Guy: The RBA is fighting inflation as well as demographics

The Reserve Bank of Australia is fighting an uphill battle against demographic trends.

The Reserve Bank of Australia is fighting an uphill battle against demographic trends. Photo: AAP/TND

Since it’s discussed every day in the news, I figured this week we think through the demographics of rising interest rates. Remember that this will be purely the demographic perspective and that this column can’t possibly do justice to the topic.

Let’s lead with the main takeaway. The Reserve Bank of Australia (RBA) is fighting an uphill battle against demographic trends.

The RBA must either changes the goal posts (unemployment and inflation rates) or it will need to hike interest rates to a level so high that poor Australians and younger Australians bleed through the nose.

What does the RBA want to achieve?

The RBA is mandated to do three things. Contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people. That means the RBA is tasked with keeping inflation in the Goldilocks Zone (2 to 3 per cent).

Further, the RBA declared the desired unemployment rate to be around 4.5 per cent (currently it sits at 3.6 per cent). The third goal of ensuring that Australians are prosperous is so vague that it can be ignored for all intents and purposes.

Today the RBA finds itself faced with inflation that is higher than its target and employment that is lower than its target. The only real tool the RBA has to achieve its three mandates is moving the cash rate up or down.

Our demographic profile dictates low unemployment

I described previously how the skills shortage is going to stay with us for another decade even if we import heaps of workers from overseas. The big Baby Boomer (born 1946-63) cohort retires in the coming decade. At the same time only a small cohort enters the labour market.

As if this wasn’t enough of an imbalance, the huge Millennial (born 1982-99) cohort has over a decade worth of baby-making left in the tank. Meaning, the biggest group of employees leaves their jobs at least temporarily.

The advent of the gig economy made it easy for people to quickly grab a casual job if they are made redundant or if the household needs a quick cash infusion. This pushes at least some people from collecting unemployment benefits to earning a wage and in the process driving down the unemployment rate.

Simply put, the unemployment rate wants to be super low in the coming decade. That’s the opposite of what the RBA wants right now.

Curbing consumption isn’t all that easy

The RBA wants Australians to consume less because lower consumption is meant to decrease inflation. The logic is that if high interest rates reduce demand for goods and services, companies can’t raise prices and inflation goes down. The RBA can just hike rates until inflation settles between 2 and 3 per cent and all is hunky dory. Well, not quite that simple … here, too, the RBA faces demographic headwinds.

Aussies are a lifestyle-obsessed people who love to consume. Older people are meant to consume less. This time around we don’t have a small cohort of poor old pensioners, as we might’ve seen in the past. While poor, aging Australians certainly exist, the group as a whole has heaps of savings. This pile of savings only gets bigger in a high interest rate environment.

Rising interest rates disproportionally hurt low-income Australians and young Australians. People in their 30s and 40s tend to have negative savings as it’s likely many have just bought a home. Their consumption needs are only increasing, though, as they start families.

We now see a trickling of wealth from the big 65+ savings pile to the 35-44 pile. People with low savings who have parents with high savings won’t stop consuming.

Today’s retirees are richer than ever. Even young people locked out of the housing market by high prices and high interest rates tend to have cash savings. They arguably continue to consume at relatively high rates as they push the goal of homeownership further into the future.

What now?

Quick recap, while the RBA wants higher unemployment, demographics push us towards lower unemployment. The RBA also wants to slow consumption while demographics push us towards higher consumption. The RBA fights an uphill battle against demographics.

By continuing to raise the cash rate, the RBA would eventually create unemployment. The people that would stop spending are overwhelmingly low-income workers. This is associated with massive pains for this cohort.

Businesses servicing the bottom end of the market would let quite a few people go. The federal government will feel the need to spend big on these new unemployed workers – they can afford to do so considering the recent budget surplus. This spending will drive up consumption and drive down unemployment.

By continuing to raise the cash rate, the RBA can kind of slow down consumer spending and can push more people into unemployment. Voila, two of its three mandates are then fulfilled only to have wrecked the third mandate of economic prosperity and welfare of the Australian people.

An impossible situation

Something has to give. I am in favour of temporarily dropping the unemployment target of 4.5 per cent. Let the unemployment rate go down as much as it wants (if it was going to go up, interventions would be much more urgent). This forces Australian businesses to finally invest big into technologies and innovations to increase the productivity.

The Global Innovation Index 2022 measured innovation related data in 132 countries. Australia continued its slide down the ranks. Six years ago, Australia was placed on rank 17, by 2022 we reached 25.

Australia urgently needs to embrace innovative technologies, to improve labour productivity. Such change usually occurs under pressure. Such pressure is not in sight. We make money by selling mining and agriculture products to the world. Prices for both are likely to climb in the coming decades, meaning the same small workforce in these industries is producing more wealth.

Resource wealth is a curse for innovation – we just don’t feel the pressure to do things differently. Record low unemployment forces us to move up the innovation ladder and unlock new opportunities for economic growth.

The RBA’s recent move to halt the cash rate and play the waiting game is a welcome shift in strategy. Let’s not intervene as long as inflation moves into the right direction (that is towards the 2 to 3 per cent band) and let’s ignore the unemployment rate. This way the RBA’s third mandate of looking after the economic prosperity and welfare of the Australian people might be best served.

Demographer Simon Kuestenmacher is a co-founder of The Demographics Group. His columns, media commentary and public speaking focus on current socio-demographic trends and how these impact Australia. Follow Simon on Twitter, FacebookLinkedIn for daily data insights in short format.

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