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Reserve Bank governor Michele Bullock has directly linked government spending to this week’s decision to lift official interest rates, undermining Treasurer Jim Chalmers’ efforts to distance himself from the nation’s growing inflation pressures.
During three hours of at times heated questioning by Liberal members of the House economics committee, Bullock conceded that private and government spending were together adding to demand across the economy, which was resulting in high inflation.
Chalmers has been under pressure from the opposition since the bank lifted the cash rate a quarter of a percentage point on Tuesday, with accusations that government spending – which as a share of the economy will hit a five-year high of 26.9 per cent in 2025-26 – forced the Reserve’s hand.
Bullock said three factors behind the lift in the cash rate were: a much stronger global economy; a lift across private sector spending; and apparent evidence that domestic financial conditions were not restricting economic activity as much as the bank had estimated.
Aggregate demand, she said, was stronger than estimated and pushing up against the ability of the economy to supply all the goods and services demanded by consumers.
Pressed on whether the federal government’s own actions were adding to aggregate demand, Bullock said it was “logical” that public spending plus private expenditure was part of overall economic activity.
“Government spending is part of total spending and total aggregate demand in the economy. So it, along with private spending, contributes to aggregate demand,” she said.
“And so to the extent that aggregate demand is above aggregate supply, which we think it is, that’s contributing to inflationary pressures and that’s why we’ve decided to raise interest rates just a bit.”
Bullock said slower growth in demand from both the public and private sectors could help the economy come into balance, which would reduce inflation that the bank is expecting to remain above 3 per cent until next year.
This week, Chalmers constantly rejected suggestions that the bank had been forced into lifting the cash rate because of government spending, which is expected to grow by almost $60 billion this financial year to a record $786.6 billion.
When the Reserve’s decision was announced on Tuesday, he noted that the bank had not referenced government spending as a contributing factor.
“Pressure on inflation, the big contribution to growth in our economy, is coming from private demand and not public demand, and that is clear,” he told parliament.
But shadow treasurer Ted O’Brien said Bullock had “obliterated” Chalmers’ argument.
“Jimflation is real, and if the treasurer can’t take responsibility for the problem, then he can’t be relied upon to fix it,” he said.
But Chalmers said it was the opposition being misleading about his own comments and those of Bullock.
“The point that I have made, and that the RBA governor made several times today, is that growth in private-sector demand has increased faster than expected at the same time as public demand growth has retreated,” he said.
“No one in the government has contested that public demand is a component of aggregate demand, and for our opponents to suggest otherwise is characteristically dishonest.”
The governor admitted the bank’s board was unhappy that inflation had been above its target for much of the past six years, after about five years below the target before the pandemic.
“That does weigh on the board’s thinking … and that is the big reason why they decided to lift the interest rate,” she said.
Some economists have criticised the bank for not pushing up interest rates as high as many overseas counterparts.
She noted that the central banks of Canada and New Zealand, which both took their key lending rates to at least 5 per cent, had brought down inflation, but at a heavy cost to their job markets.
“They took interest rates much higher than us, got inflation back down, but they’ve both got very high unemployment. Canada’s got a six in front of it, New Zealand’s got a five in front of it,” she said.
“We could have taken that approach, but we didn’t. We’ve always thought it would be difficult to achieve, but it’s something worth achieving.”
Financial markets expect the Reserve to lift the cash rate by another quarter percentage point at its June meeting before holding it at 4.1 per cent through the next year.
But some economists believe the bank will have to go further. Capital Economics’ senior economist Abhijit Surya on Friday said he expects the RBA to push rates back to 4.35 per cent – where it was before it started cutting rates – to “slay the inflation dragon for good”.
Complicating the bank’s efforts to control inflation is the large percentage of borrowers who did not reduce their mortgage repayments as rates came down.
Analysis by the e61 think tank found about 90 per cent of borrowers left their repayments steady, helping them to pay down their mortgage quicker while beefing up savings that could be redrawn at a later date.
Research director Gianni La Cava said the rate hike would be largely felt through lower savings and reduced mortgage buffers.
“Household spending will continue to be insensitive to further interest rate hikes, so long as the buffers are not eroded too much,” he said.
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Shane Wright is a senior economics correspondent for The Age and The Sydney Morning Herald.Connect via X or email.From our partners
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