Reserve Bank of Australia says the economy is slowing, defying Abbott government predictions that axing the carbon tax would strengthen it

The Reserve Bank’s decision on Tuesday to lower the cash rate to 2.25% was based on a view that Australia’s economy is slowing. The treasurer, Joe Hockey, suggested the decision was made possible due to the removal of the carbon tax. But that argument only highlights the way claims that the carbon tax removal would improve the economy have fallen flat.

The decision to cut interest rates was a pretty damning assessment of the economy by the RBA. The cut to 2.25% was the RBA putting its foot on the accelerator, and the market believes the economy is so weak it will do so again, with a 40% chance of a cut to 2.0% next month.

The RBA made the reasons for the cut abundantly clear in its statement – the economy is not growing fast enough.

Reserve Bank of Australia interest rate cut – Glenn Stevens' statement in full Read more

In December the RBA’s assessment was that “in Australia, most data are consistent with moderate growth in the economy”. On Tuesday this had changed to stating that “in Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak.”

Given the RBA rarely changes the words of sentences in its statement, let alone whole passages, the change was pretty dramatic.

Hockey ignored this drama in his press conference on Tuesday, and instead went for comedy by focusing on inflation and the carbon tax.

He argued that “the government is working hard to take the pressure off interest rates by keeping inflation low”.

He suggested that this lack of pressure is “what we’ve been focused on; fixing up the challenges of the budget and reducing the upward pressure on inflation and that’s come to bear with lower interest rates.”

It’s rather interesting for a treasurer in a period of rising unemployment to say his focus is on keeping inflation down rather than employment up. But it underscores that Hockey, despite his occasional forays into Keynesian economic speak, where he talks about not wishing to cut the budget too hard for fear of reducing growth, in his heart believes monetary policy is the best way to stimulate the economy.

More curious though is his belief that removing the carbon tax received a tick of approval from the RBA, and was also a main reason for why it cut rates.

He argued that the RBA “recognised” the removal of the carbon tax “as one of the contributors to this decision.”

Indeed the RBA did mention the carbon tax, but it was clearly done to provide a bit of context in a paragraph which noted the current level of inflation.

It noted that “the CPI recorded the lowest increase for several years in 2014. This was affected by the sharp decline in oil prices at the end of the year and the removal of the price on carbon”.

The context is important, because the RBA doesn’t care about one-off hits to inflation. It knows that things happen every now and then that cause prices to jump or fall, but that doesn’t cause it to cut or increase rates. What the RBA worries about is the underlying inflation.

The mention of the carbon tax was merely to explained why inflation was low – ie one-off impacts – not due to dangerous signs of deflation.

In September 2012 the RBA said much the same thing about the introduction of the carbon price. It noted, “the introduction of the carbon price affected consumer prices in the September quarter, and there could be some further small effects over the next couple of quarters”.

The RBA’s two measures of underlying inflation – the trimmed mean and the weighted median – try to take out the volatility of the one-off impacts.

While the CPI rate rose 1.7% in the past year – well below the 2% to 3% band the RBA worries about – the trimmed mean inflation index grew by 2.2%. That 2.2% growth was also the exact amount it grew by in the same period in 2012 after the introduction of the carbon price.

The problem for Hockey boasting about the removal of the carbon price taking the pressure off inflation is that it has done all that it is going to do on that score:

When the carbon price was introduced in July 2012, electricity prices in the next quarter rose 15.3%. But in two of the next three quarters they fell (as they often do). The annual growth of electricity prices did zoom, but once that September 2012 quarter was no longer counted, the price rises went back to normal – in fact were lower than they had been prior to the introduction of the carbon price.

The same thing will happen once the September 2014 quarter is no longer counted.

The reality is, contrary to Tony Abbott’s suggestion that the carbon tax would cause prices to go “up and up and up”, it caused them to go up once, and that was it. Similarly the removal of the carbon price causes electricity prices to go down once, and that’s it.

But the bigger problem for Hockey is that in the past he didn’t just boast that removing the carbon tax would bring down electricity prices. He and Abbott (and everyone else in the government) claimed it would spur growth in the economy.

In March last year Hockey told parliament that “we have to grow the economy faster to improve the speed of economic growth to start to drive down the level of unemployment in the economy”.

This is certainly true.

But he went on to argue that “the best way to do that, the most immediate way to do that, is to remove the shackles on business”.

And what was this way? It was the “repeal of the carbon tax”. He listed a number of business groups who wished the carbon tax to be repealed and he argued that the repeal of the carbon tax was “one way that you can immediately lift the speed of Australia’s economic growth”.

If this were the case you would expect the RBA to have made note of this fact in its statements. Surely it would have noted that while growth was “below trend” it needed to wait to see the full impact of the removal of the carbon tax.

But no.

In March last year Hockey argued that “the best thing we can do, the most constructive thing we can do for the economy right now, is to have the Labor party in the Senate change its mind and repeal the carbon tax”. And yet, seven months after its removal, the RBA says that “growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected”.

The only sign of the carbon tax in the RBA’s statement was related to inflation – and that was only to look to the past. When it came to the future, the RBA saw no impact of the carbon price, and no belief that interest rates could remain steady due to any “immediate lift” in the “speed” of the economy brought by the carbon tax’s removal.

Hockey can keep saying the end of the carbon tax allowed the RBA to cut rates, but what he perhaps should ponder is why – despite the removal of the carbon tax – they still needed to.