The US January CPI and the Australian inflation and wages outlook: pushing out the peak in the inflation process?

Plus, landing the RBA review

Feb 17, 2023

The US January CPI came in as expected at 0.5% m/m and 6.4% y/y, although this represents an acceleration on the monthly pace seen in November and December last year.

The Cleveland Fed’s trimmed mean measure came in at 0.6% m/m, which is also an acceleration on the average monthly increase of 0.4% seen in Q4. At an annual rate, the US trimmed mean is running at a steady 6.6%. The weighted median rose to a new high of 7.1%. The weighted median is just a special case of the trimmed mean with an arbitrary 50% trim. Non-arbitrary trims designed to better capture the persistent component of inflation typically model better.

If the January increase in the US trimmed mean is typical of the rest of Q1, then the implied forecast for Australia’s Q1 trimmed mean is 1.7% q/q and 7% y/y. This would push out the peak in the local inflation process to Q1 2023 instead of Q4 2022 and marginally higher than Q4’s 6.9% y/y rate. But we still expect to see more moderate outcomes in the US in February and March that lower the local forecast for Q1 to be consistent with a Q4 peak.

Since the end of January, the market-implied forecast for the Fed funds rate and the ECB’s official rate have been revised up and this has contributed to a re-pricing of the outlook for the RBA’s official cash rate, helped along by the RBA’s February Board meeting and Statement on Monetary Policy. Matt Cowgill has once again helpfully visualised the changes in the RBA’s forecasts relative to the previous statement:

The higher for longer theme is evident in the inflation projection. The forecast for business investment is a notable downgrade.

Consumer sentiment fell sharply in February, particularly for those respondents surveyed after the February RBA Board meeting:

Remember when the RBA claimed that rate cuts hurt sentiment? You’re hearing it less and less!

In his appearance before the House Economics Committee on Friday, RBA Governor Lowe conceded there was also ‘no great science’ behind the view in the October 2022 Board minutes that staggered interest rate increases ‘would also help to keep public attention focused for a longer period on the Board’s resolve to return inflation to target.’ Zac Gross had an effective critique of this view. As noted here previously, hedging is a sufficient rationale for interest rate smoothing without invoking behavioralist assumptions about the public’s attentiveness to monetary policy. Lowe said as much in Friday’s testimony. Lowe and Ellis wrote a good paper on the topic of interest rate smoothing in 1997, which also discusses the role of smoothing in communicating policy to the public, but the discussion in that paper did not rest on claims about the public’s attentiveness to policy.

Next week’s Australian Q4 wage price index

The Q4 wage price index next week remains a contest between the lowest unemployment rate since 1974 set in October last year and a possible Q4 peak in the inflation process on the one hand and the inertia built into the wage setting process on the other. That inertia is just one more reason to view wages growth as more symptom than cause of inflation. The market is expectng 1% q/q and 3.5% y/y. I get 1.2% q/q and 3.7% y/y compared to 3.1% y/y in Q3, which won’t do the short end any favours.

Landing the RBA review

The Treasurer has indicated that the RBA review will report before 31 March and that the government will respond to the review before the 9 May federal Budget. The government has also flagged a decision about Governor Lowe’s future around mid-year ahead of his current seven-year term ending in September. According to Troy Bramston:

The view of senior ministers and backbench Labor MPs is that this is such a catastrophic failure that it would be intolerable to renew Lowe’s tenure as governor, perhaps taking his term to 10 years like his two predecessors. The cabinet and the caucus will riot if Lowe is reappointed. Chalmers must surely be mindful of this sentiment, and the views of voters in mortgage belt seats.

With this sentiment in mind, the commentariat are starting to speculate about Lowe’s successor. There are some obvious candidates, as suggested by John Kehoe, although the main question in relation to many of the names being proffered is not so much whether they could do the job, but whether they would want it given where they currently sit.

RBA review panelist and former BoC Senior Deputy Governor Carolyn Wilkins has been suggested and would be a logical choice to implement the recommendations of the review, but that might depend on the extent of government agreement with those recommendations. Hopefully, she has been enjoying her time in Australia!

Amid this speculation, very little consideration has been given to the monetary policy views of prospective appointees to the Governorship or the Board, something that gets much closer attention in the US. Employ America has played a very important role in drawing attention to the views of prospective Federal Reserve Board members in the context of the Congressional confirmation process. Their not-so-radical suggestion was that those nominees who held mistaken monetary policy views in the past should not be given the opportunity to repeat those mistakes.

One rationale for appointing to academics to the role of monetary policy decision-maker is not only that they have thought seriously about the role of monetary policy in the economy, but that their views can be readily interrogated through their research output. It is interesting that the Japanese government has broken with long-standing convention (in Japan at least) and nominated an academic to the role of BoJ Governor, subject to confirmation by the Diet.

The CAMA Shadow RBA Board is perhaps a useful sandbox in this context, allowing prospective appointees to a future monetary committee to demonstrate a track record of sound monetary policy reasoning and decision-making before being appointed.

If I were Treasurer, I would give prospective appointees a copy of Scott Sumner’s The Money Illusion as homework and then invite them back for a monetary policy viva voce. The point is not so much that they should agree with all of it, but they should at least understand the significance of that perspective. It might also be worth asking prospective appointees their view about the effect of changes in the cash rate on consumer and business confidence. If they express a belief in the three dimensional chess of perverse signalling effects, aka ‘stability and confidence,’ they probably shouldn’t be allowed near the rate setting process.

ICYMI

Why We Need To Achieve Housing Abundance.
House Prices and Consumption: A New Instrumental Variables Approach. My growing sense of this literature is that the more robust the identification strategy, the closer the elasticity of consumption to housing wealth approaches zero (the authors get 0.1).
Memes and themes: