The RBA had no choice but to tighten the screws

In the past two weeks we have seen both confirmation that Australia has an inflation problem, and the Reserve Bank’s response to that problem.  

According to OECD data for the year to December, only a small number of comparable countries exceeded our 3.8% inflation rate, with the majority falling below it, often under 3%. We have previously been a high-inflation country — in the 1980s — and being in that position did not end well. 

Related to that, the RBA has just become the first significant central bank to reverse the recent series of interest rate reductions. 

The RBA was too eager to lower interest rates last year and must be held to account for that policy error. The government is no doubt happy to let Martin Place take the blame. But is it as simple as that? 

The RBA is responsible for monetary policy and as Milton Friedman once said, “inflation is always and everywhere a monetary phenomenon” – meaning that any outbreak of inflation can eventually be snuffed out by tight money and can only be sustained if monetary policy allows it to be.  

This is no doubt true, and it was tight money that squeezed out the inflation of the 1980s and brought Australia into line with international inflation norms. 

However, to acknowledge the power of monetary policy is not to deny that non-monetary phenomena can make its task harder and increase the costs of curbing inflation. These can be shocks from abroad or home-grown, including government policies. 

The government has been rightly blamed for fuelling the inflation flames with too rapid growth of its own spending. This has come not just from the federal government but from several state governments as well.  

There are some signs that the growth of public sector demand moderated in 2025 following the strong growth of 2023 and 2024. However, how long this moderation lasts is an open question in light of upward revisions of future expenditure estimates. 

Aside from expenditure, there are other ways in which government policy has helped fuel inflation and made the job of monetary policy harder. 

The Albanese government is the first since the Whitlam era to come into office vowing to force up wages. In Albanese’s case, the mantra was “get wages moving again” and this has been backed up by a raft of workplace legislative changes and encouragement of dubious “gender equity” cases and out-sized minimum wage increases. 

There is nothing wrong with wanting to see real wages increase in a non-inflationary way backed up by productivity growth. However, the drive to “get wages moving again” has disregarded the fact that there has been little or no productivity growth. In this situation, boosting nominal wage increases is a recipe for inflation, but the government has so far been let off the hook for an inflationary wage policy. 

Unit labour costs are the best gauge of the pressure of labour costs on prices, and they have been increasing at about 5% a year for the last four years. If wages increase but productivity doesn’t, then unit labour costs will increase and given how pervasive labour costs are in production processes then selling prices will increase. With unit labour costs increasing at 5% a year it is difficult for inflation to stay below 3% a year. 

Compounding this is the effect of expectations. Businesses and workers now anticipate higher inflation, which feeds into pricing and wage-setting behaviour.  

Once expectations become anchored, even tight monetary policy may have to work harder to bring actual inflation down.  

The RBA faces the difficult task of convincing the public that higher interest rates will succeed without unduly constraining economic growth. This delicate balancing act requires not only monetary discipline but also public credibility. 

The third way in which government policy has contributed to inflationary pressure and complicated the task of monetary policy, apart from expenditure growth and wages policy, is through its energy policy.  

The dash for renewables at any cost and discouragement or outright prohibition of new onshore gas supply has driven up energy costs for both households and business. Households see this in their electricity and gas bills but also bear the cost when businesses pass on their higher energy costs in higher prices for a much wider range of goods and services. 

There are also broader structural and regulatory issues that have played a role in keeping inflation elevated. Moreover, some regulatory hurdles in housing and construction markets have limited new supply, contributing to ongoing upward pressure on property rents, which feed directly into the consumer price index. 

In short, while monetary policy remains the ultimate tool for controlling inflation, it cannot be seen in isolation.  

Government fiscal policy, energy strategy, wage-setting interventions, and supply dynamics all interact to make the task more complex and costly.  

The RBA’s rate increase is necessary. But the public would be well served by a frank acknowledgement by Jim Chalmers that controlling inflation is the responsibility of government as well as the Reserve Bank. 

Ultimately, the RBA is raising interest rates not because of some abstract economic cycle, but because years of excessive government spending have fuelled demand beyond the economy’s capacity.  

And this has left the central bank with a far heavier lift load than would otherwise have been the case 

Australians are now paying the price for a profligate fiscal appetite that has left the RBA no choice but to tighten the screws. 

Robert Carling is a Senior Fellow, and Michael Stutchbury is Executive Director, at the Centre for Independent Studies. 

Photo by Ron Lach : https://www.pexels.com/photo/gold-screw-on-a-wooden-surface-8832029/

Photo by Polina Tankilevitch: https://www.pexels.com/photo/close-up-shot-of-screwdrivers-5583095/