LACHLAN KERWOOD-MCCALL: RBA’s rate hikes don’t work. It’s time for a new approach to fight inflation

The Reserve Bank’s pivot on monetary policy in the wake of re-accelerating inflation has brought renewed scrutiny on Australia’s inflation-fighting framework.

With early signs of rising unemployment, an urgent discussion is needed about whether we have the tools in place to prevent stagflation.

While some have criticised the bank for not raising rates more aggressively post-COVID, others rightly point out it is ill-equipped to deal with global supply-side shocks.

While rate hikes won’t lift global oil production or get ships moving any quicker, they do in theory lift the exchange rate, making imports cheaper in the face of global cost-push inflation.

Nonetheless, several factors limit their effectiveness and appropriateness today.

Firstly, monetary policy affects the economy through lags that are both long and variable, as the RBA has noted.

RBA research based on its own models indicates a policy shock’s peak effect occurs after one to two years. While some effects are felt sooner, it’s a long time to wait for the cavalry to arrive in full.

Secondly, research from UNSW, the University of Chicago, e61 and others using bank transaction data found post-COVID rate hikes had no net effect on homeowners’ consumption.

Rather than incentivising saving and disincentivising consumption, rate hikes saw mortgage holders spend down their COVID-era savings to meet higher mortgage costs and continue consuming at the same levels.

Thirdly, recent research has found monetary policy affects business R&D investment and innovation, and thus productivity growth and potential output.

Raising borrowing costs also reduces capital investment, hindering capital deepening and productivity growth. The last thing we want when facing supply-side shocks is lower productive capacity growth.

Fourthly, rate hikes redistribute income from borrowers to savers, workers to bankers, and working-class families to high-income individuals.

The Resolution Foundation even found UK rate hikes lifted British household sector income (by £34 billion from higher interest on savings accounts) more than it raised household debt costs (by £18 billion) — a net £16 billion (or 1 per cent) increase.

Asset-rich households gained, while younger mortgage-holding households were hit hardest. While this case also reflected specific circumstances, it reflects an uncomfortable truth: monetary policy is a class issue.

Better inflation management requires tightening demand where it is unproductive while expanding the economy’s productive base. That means being more disciplined about speculative excess, more focused on supply, and more intentional about how government spends.

On the tax side, the priority should be to dampen unproductive demand — particularly in asset markets — while preserving incentives to work and invest productively.

Reforming capital gains tax is central here. The current discount distorts behaviour by encouraging leveraged property speculation and bidding up existing assets rather than directing capital into new, productive investment.

Scaling back the CGT discount would reduce investor demand in overheated housing markets, ease pressure on prices, and redirect capital toward more productive business formation and expansion.

Alongside this, there is a strong case for a targeted windfall profits tax. Where firms have benefited from exogenous shocks — such as the global energy price surge — without corresponding increases in productive effort, while households and workers bear rising bills and stagnant wages, a temporary windfall levy can both curb price-gouging incentives and return economic rents to the public.

Properly designed, it reinforces fairness, and fights inflation driven by market power rather than wages.

But discipline on the revenue side must be matched by the right kind of discipline on spending.

We should prioritise productive expenditure over untargeted cash giveaways that inflate demand without building capacity.

One concrete reform would be to phase down broad, untargeted consumption subsidies and instead invest those funds in a national program of trade-linked apprenticeships and on-the-job training tied directly to new forms of climate-friendly (manufactured) housing and electrification programs.

This would be co-designed with workers and employers, include wage subsidies for apprentices, and require guaranteed job placement on completion. The result is fewer dollars chasing scarce goods, and more skilled workers expanding supply where inflation is most acute—especially in housing and energy.

Finally, fiscal frameworks matter. Governments should adopt a formalised inflation-neutral budgeting framework so that any new spending likely to add to inflation is offset elsewhere or paired with measures that expand productive capacity.

This embeds discipline without abandoning growth. The Budget Process Operating Rules should be updated with two clear tests.

First, an inflation-neutral budget rule: when inflation is above 3 per cent, any proposal that risks adding to price pressures must be matched with inflation-neutralising offsets, preventing governments from overshooting the runway, and hardwiring responsibility into decision-making.

Second, a productive capacity rule: when inflation sits between 2 and 3 per cent, ministers can proceed with growth-supporting spending, but only if it is accompanied by measures that expand supply — such as skills, infrastructure, energy or housing — so the long-run inflation impact is neutral.

In short, we build more runway ahead of time, not after we are already in trouble.

There is no need to accept inflation as an inevitable trade-off against fairness or full employment.

With the right mix of CGT reform to curb speculative demand, a windfall profits tax to tackle excess rents, and a sharper focus on productive expenditure, Australia can restore price stability while strengthening the real economy.

Lachlan Kerwood-McCall is an economist at the John Curtin Research Centre