The International Monetary Fund (IMF) has called on the Australian government to rein in public spending to avoid stalling the country’s progress on inflation and to prevent further hikes in interest rates. The Washington-based financial institution cautioned that despite inflation easing from its pandemic-era highs, underlying economic pressures remain, particularly in sectors not influenced by international trade.
In its latest assessment of the Australian economy, the IMF noted that inflation had decreased to 2.8% by the third quarter of 2024, a sharp drop from post-COVID peaks. However, it emphasized that the broader economic recovery is still fragile, with persistent inflationary pressures in domestic, non-tradable sectors.
Inflation Outlook and Economic Risks
The IMF projects that inflation will return to the Reserve Bank of Australia’s (RBA) target range of 2-3% by the end of 2025, but warns that a stall in disinflation presents a significant risk to the country’s economic outlook. If inflationary pressures do not continue to fall, the RBA may face difficulties in keeping interest rates stable, which could further strain consumer spending and investment.
Since May 2022, the RBA has raised its official cash rate from 0.1% to 4.35% in a bid to control inflation, which has dropped from 6.6% to 2.8% in the September quarter of 2024. While financial markets expect a potential reduction in interest rates starting in 2025, the timing of this remains uncertain, with forecasts suggesting that cuts could begin between February and May.
Fiscal Policy’s Role in Supporting Disinflation
The IMF’s report stresses that fiscal policy must work in tandem with the RBA’s monetary tightening. While the RBA’s restrictive monetary stance is seen as appropriate, the IMF warns against any expansionary fiscal policies that could undermine efforts to control inflation. In particular, government expenditure must be carefully managed to avoid increasing aggregate demand, which would slow down the disinflation process.
The IMF cited several factors that could disrupt the disinflation trajectory, including labor market tightness, unexpected fiscal stimulus, and a lack of spare capacity in the economy. These factors, the IMF warns, could lead to prolonged high interest rates, which would suppress consumption and investment. Conversely, if economic growth weakens more than expected, or unemployment rises faster than anticipated, the RBA may be forced to reduce rates earlier than planned.
Future Policy Recommendations
Given these risks, the IMF suggests that the Australian government should prioritize expenditure rationalization at all levels to reduce aggregate demand. In the event that inflationary pressures persist, the IMF recommends that both fiscal and monetary policies may need to tighten further to ensure the economy stays on track.
In its conclusion, the IMF reiterated that Australia’s fiscal and monetary policies must complement each other to effectively combat inflation and ensure long-term economic stability. A coordinated approach will be essential to achieving the RBA’s inflation target without harming growth prospects or triggering excessive interest rate hikes.
Image by Ken Nakagawa: https://commons.wikimedia.org/wiki/File:IMF-Seal_ENG_RGB.svg
