Rate rises or recession: pick one to worry about, not both

Interest rate rises or recession: pick one to worry about, not both (smh.com.au)

Jessica Irvine| Sydney Morning Herald| 7 June 2022

There is an emerging concept in psychology known as “subjective wellbeing homeostasis”.

Homeostasis is, of course, a well-established phenomenon in biology. The human body is known to run a range of self-regulatory feedback loops to maintain various internal physical set points, including temperature and fluid balance.

More recently in the field of psychology, it has been argued, perhaps most notably by Australian psychology professor Robert Cummins, there also exist mental processes which regulate a person’s sense of their own wellbeing.

Over time, no matter what shocks we may encounter – be it divorce, job loss or the loss of a loved one – humans have been observed to have a tendency to return to an individually determined internal set point for satisfaction, or happiness.

At a population level, our average happiness level is remarkably stable.

Indeed, the answer to the eternal question “how are you?” has been well established in the psychological literature. The answer, according to the long-running Australian Unity Wellbeing Index, is: “about 7.5 out of 10, thanks”.

Millions of mortgage holders are braced for predictions the Reserve Bank will lift interest rates higher than first thought. Which is not to say that external shocks like job loss or a global pandemic don’t knock us off our perch. Only that once the shock is passed, we tend to revert to our usual level of happiness, both as individuals and in aggregate.

“The stability of subjective wellbeing at the level of population sample mean scores is remarkable,” Cummins observes. “Actually, it is extraordinary!”

Which may help to explain, I think, the remarkable resilience Australians have – in aggregate – shown to the pandemic.

It was not so very long ago – remember – that we were variously confined to within five kilometres of our homes, subjected to nighttime curfews and serious fines for breaching pandemic lockdown rules.

How quickly we move on. Within the space of a year, we’ve gone from worrying about the imminent death of elderly loved ones and the potential for skyrocketing joblessness to worrying about the spectre of rising prices.

There are grim warnings, both globally and at home, that rising interest rates are about to push us into recession again.

In the US, JP Morgan CEO Jamie Dimon is urging investors to “brace yourself” for an economic “hurricane” as the US Federal Reserve flirts with tipping the world’s largest economy into recession to stop high inflation.

Of course, some people will always be worried the sky is about to fall in. Journalists number among them. Indeed, it is our professional responsibility to scan the horizon for corruption, misdemeanours and any threats requiring democratic attention. And it is through that work that threats are often brought to attention and avoided.

But the sky didn’t fall in on the economy during the pandemic, as feared, precisely because policymakers went to great lengths to avoid that happening.

And guess what? The sky’s probably not going to fall in now that inflation is picking up. Why? Because policymakers will go to great lengths to avoid that happening.

And anyway, some interest rate increases – including this Tuesday’s near-certain hike – are not a portent of doom.

They’re actually a positive sign of homeostasis at work in the economy. Released from our homes and amid low joblessness, we’re only able to have inflation because businesses feel more confident to pass higher prices on to us.

Guys, that’s good news.

Could the Reserve Bank accidentally tip us into recession by jacking up interest rates too fast? Sure. That’s always a risk.

But there’s little credible reason to suspect those same policymakers who went to such great lengths to protect jobs growth during the pandemic will now flip the switch to a short-term obsession with controlling prices regardless of employment outcomes.

Our central bank has – by explicit design – a multifaceted mandate to both achieve price stability in the economy and to promote the full employment and general welfare of the Australian people.

It’s true that mandate has found expression in recent times in a commitment to keep consumer prices rising between 2 and 3 per cent over time. But price stability is not the end point in itself, but merely an important means to the end of achieving a well-functioning and fully employed society.

It’s true that financial markets are pricing an aggressive series of interest rate hikes over the coming year or two which, if inflicted, would likely tip us into recession.

But there is little chance of that actually happening.

Mortgage holders fearful of both rate rises and a recession should do themselves a favour and pick one to focus on. You can worry about rate rises, or you can worry about a recession, but it doesn’t make sense to worry about both at the same time. Why? Because rest assured, if we do hit a recession, the Reserve Bank won’t still be raising rates.

In the meantime, it makes sense for households to focus their attention on the thing they can control: their reaction to rate rises. No doubt indebted households must now start adjusting their spending behaviour as interest rates rise to more normal levels in the months ahead. There’ll be less wiggle room than there has been for meals out, holidays and overpaying on essential services by not shopping around for the best deals.

Our economic set point is returning to more normal levels. And that’s a good thing. And both history and psychology suggest we’ll adjust quite quickly, too. It’s what we do.