Memo to New RBA Governor: To Reduce Inflation, We Must Reduce Profits

by Jim Stanford


Treasurer Jim Chalmers last week announced the appointment of Michelle Bullock as the new Governor of the Reserve Bank of Australia. Bullock has worked at the RBA for almost four decades, and as Deputy Governor and Deputy Chair of the Reserve Bank Board (which sets interest rates) she has been fully engaged in the RBA’s recent record-breaking monetary tightening.

Does Ms Bullock’s appointment open an opportunity for rethinking some of the RBA’s long-held assumptions and biases? In this commentary (originally published in The New Daily), Centre for Future Work Director Jim Stanford suggests she could start by reconsidering the Bank’s single-minded focus on labour costs as the prime source of inflationary pressures — and consider the role played by record corporate profits.

Memo to New RBA Governor: To Reduce Inflation, We Must Reduce Profits

When Treasurer Jim Chalmers announced the appointment of Michele Bullock as new Governor of the Reserve Bank, he lauded her “fresh perspective.” That’s a stretch, given that Ms. Bullock has worked at the RBA since 1985. And no-one expects her to change course on interest rates, which the RBA hiked 12 times since last May.

If indeed Ms. Bullock brings fresh eyes to this role, let’s hope she uses them to review a broader range of the factors causing inflation – rather than focusing myopically on the dangers of wage growth, like her predecessor Dr Philip Lowe.

From the outset of the current inflation, Lowe focused squarely on labour costs as the biggest worry – while rejecting that record corporate profit margins had anything to do with high prices.

For example, last month Lowe warned a Sydney business audience that rising labour costs were a clear and present danger in the fight against inflation. The 3000-word speech did not mention the word “profit” once. Previously, Lowe had dismissed outright concerns that record-high profits for Australian corporations since 2021 were connected to the simultaneous surge in inflation.

In short, Philip Lowe looked only to one side of the tracks in analysing what caused inflation – and what to do about it. That put him out of step with other central banks and many international institutions. They’ve produced volumes of research confirming higher profits accounted for the largest share of inflation since the pandemic.

These organizations are not wild-eyed radicals: they include the OECD, the International Monetary Fund, the U.S. Federal Reserve, the Bank for International Settlements, the European Central Bank and the European Commission. Here in Australia, studies from the Australia Institute and the Centre for Future Work confirmed the same thing happened here.

This evidence that record profits, not undue wage growth, fueled post-COVID inflation sits uncomfortably with economic orthodoxy, which asserts by rote that that inflation always results from overheated labour markets, excess demand, and rising wages.

Will Ms Bullock more honestly consider this evidence, and adjust her policy approach accordingly? Her recent speech (just before being appointed Governor) claiming that unemployment must rise to reduce inflation does not inspire hope.

This is not just a matter of intellectual debate or rhetorical finger-pointing. Understanding what causes inflation is vital to properly designing the remedy. International agencies are now grappling with how to shrink those record profit margins in order to both calm inflation and restore real wages (which fell sharply since 2021 in most countries, including Australia).

As ECB President Christine Lagarde recently put it, real wages can gradually recover in coming years – but only if profit margins decline. If they don’t, she warned, and businesses hang onto unusually large profits, then interest rates must remain higher for longer, with resulting economic and social pain.

International experience is now confirming the importance of lower profits to lower inflation. In the U.S., for example, profits eased 8% over the last six months, as inflation fell from 9% to 3%. Wage growth has hardly changed at all.

In Spain, an unconventional combination of policies – including price caps, excess profit taxes, and subsidies to low-income consumers and renters – has kept profits at or below historic norms. Spain’s inflation fell last month to just 1.9%, the lowest in Europe.

Japan is another country which avoided a post-pandemic surge in corporate profits, keeping income distribution remarkably stable. The share of labour compensation in Japan’s total GDP has actually increased slightly since the pandemic – the exact opposite of Australia (where the labour share of GDP hit record lows last year). Inflation has remained tame in Japan, around 3%.

Canada’s experience is especially relevant to Australia, since it is also a major resource exporter. Profits there surged (like Australia) to record highs as inflation took off. They’ve since retreated by over 20%. Inflation has slowed in step: to 2.8% at last reading. An excess profits tax on banks, and special taxes on cash payouts by energy companies, helped.

The U.K. experience is the polar opposite. There, profits have kept soaring as companies exploit desperate consumers and still-fractured post-Brexit supply chains. Profits grew 17% in the last year, three times faster than wages. Not coincidentally, inflation remains at a painful 8.7%.

Australia, unfortunately, is closer to the British end of this spectrum. Despite falling world energy and commodity prices, corporate profits grew another 13% in the last year, faster than wages. The profit share of GDP remains at an all-time record high of 29%. Real wages are still falling. And inflation is still high: 7% last quarter.

How do we get profit margins back down, supporting both lower inflation and a restoration of real wages? Many policies would help: price caps on essential products (like energy and rents), taxes on excess profits, support for wages to catch up, and limits on corporate concentration.

And some of the needed moderation in profits will likely occur naturally – for both good reasons (restoration of pandemic-damaged supply chains) and bad (looming recession).

Most of those policies are beyond the remit of the RBA, requiring instead a multi-dimensional effort across government. But so long as the RBA denies that profits are even relevant, momentum to develop and enact that broader anti-inflation agenda will be stifled.

Ms Bullock could turn over a new leaf in RBA thinking by casting her “fresh” eyes more widely over both macroeconomic data and cumulating international research. And she should then acknowledge that the Bank’s single-minded focus on suppressing wages has been neither fair, nor effective.

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