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turrning the screw « Previous | |Next »
February 6, 2008

The argument from economic commentators is that the Reserve Bank needs to slow the economy by increasing interest rates yet again, since inflation is building faster than the economists realized. So there needs to be a significant slowing in demand. They now talk in terms of the focus of economic policy being on getting runaway prices back under control; waiting is not an option for the RBA; the rate rise is the right medicine; people need to feel pain; inflation must be stomped on.

The AFR says the economy is running at full throttle and beginning to overheat. Yesterdays editorial says:

Australia's economy is hard up against capacity constraints. There are bottlenecks in the labour market that have been bound to result in wages inflation. Global food and energy inflation has feed into higher costs.So what will the federal government do?

The call is that the Government must fix things. That is what it has been elected for. But what can the government do?

It cannot do anything with interest rates as that is now the task of the Reserve Bank. It cannot do anything about global energy prices. It can blame the Howard Government though. It does, and no doubt we will hear about the Coalition's negligence and failure to control inflation for years to come.

Hang a mo. Has not the Reserve Bank been rather slow to act? The signs of overheating were there during 2007, as were the signs of increasing household debt (mortgage and credit card). If the finger can be pointed at the RBA to "stomp on inflation", then that finger belongs to the federal government. It can hold the economic mandarins at the RBA responsible for getting inflation under control. The RBA needs to be held accountable.

In the RBA's defence we can say that it issued several warnings over the last couple of years that inflation was rising, that the government had to address skills shortages, infrastructure bottlenecks and other capacity constraints, and the government needed to bring its fiscal policy (those tax cuts) into line with monetary policy (interest rates). Now the Coalition was slow to act. It was seduced by the resources boom and wealth creation, and they were irresponsible in the disbursement of the resource-generated wealth. To its credit the RBA did raise interest rates during the election in November 2008.

However, the logic of the situation is this. If the resources boom boots domestic demand ( plus the tax cuts) then spending by households will have to be cut disproportionately to slow domestic demand. This is what the RBA failed to do. The reason may have been political--Howard and Costello standing in the way---and there is only so much the RBA can do---- it needs to avoid the hard landing or a recession we had to have. But it still failed. It hesitated for too long and the inflation genie or demon escaped from the bottle-- in that the inflation rate is well above the RBA's target range.

| Posted by Gary Sauer-Thompson at 8:19 AM |