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Reserve should get on with making rates 'average'

By Henry Thornton - posted Tuesday, 6 April 2010


The mining areas and some service suppliers are working as hard as they can. There is a renewed housing boom even in the old parts of the country and there are legitimate concerns that it is turning into a bubble.

Manufacturing and most small businesses are struggling, many people are working far fewer hours than they would like and there are clear signs of renewed goods and service inflation that will punish people on fixed incomes and battlers generally.

The Reserve Bank has said it is keen to return interest rates to "average" - odd it does not say "normal" - but that is a theological issue. Average or normal, the Reserve should get on with it. It is for government to sort out a policy to cope with the vast disparity of prospects between sectors and regions.

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After a long, hard winter, there are clear signs of jobs growth in the US. But 15 million Americans are still unemployed, with many more underemployed or not counted in official statistics.

House prices are still falling, vast regions are destined to rustbelt status and overall there is no cause for celebration.

Europe is grimly stagnating, hoping that dominoes led by Greece do not fall and create a new and far larger banking crisis than we have seen so far.

Budget deficits in the old world of US and Europe are large, more than 10 per cent of GDP in many European states. Sluggish growth will not fix the situation.

Increasingly, inflation will be the policy of choice rather than cuts to government spending or tax hikes, though there may be attempts in this direction in those nations that are most conservative in their economic thinking.

In the new world - actually several old empires making post-colonial comebacks - a variety of governments are riding the tiger of fast growth with clear and present dangers of inflation.

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Asset inflation is already obvious, and is usually applauded by governments of whatever variety, ignoring the fact that inflation of any sort is due to excessive purchasing power of the people within particular currency areas.

The geopolitical focus is on China within the new world of inflationary nations.

But economic growth is also strong. Within the "BRIC" nations of Brazil, Russia, India and China, the latest figures for growth of industrial production are (courtesy of The Economist): 16.0 per cent, 1.9 per cent, 16.7 per cent and 12.8 per cent.

Consumer price inflation is estimated in the year to either January or February at 4.8 per cent, 7.2 per cent, 16.1 per cent and 2.7 per cent.

Other measures of inflation, including unofficial measures, are higher and, in the case of China, the government is applying the brakes. China has a heavily managed currency and is facing with disdain US calls to allow the yuan to appreciate.

Presumably both the Chinese and the Americans know that the yuan needs to be floated rather than just increased, if China is not to import inflation from the old-world nations as they seek to dissolve their budget deficits in the least painful way.

The worst case, of course, as it was with Australia in the days of the "managed float", comes when imported inflation adds to domestic inflation. Assuming, as we must, that monetary economics 101 has penetrated the power centres in Beijing, the prospect of China catching the Australian disease is enough to make an old communist writhe uncomfortably in his bed at 3am.

Nowadays, of course, Australia has an independent central bank with a mandate to keep "underlying" consumer inflation in the range of 2 to 3 per cent while paying some attention to asset inflation (we are recently told) as well as the state of the economy. Then there is the Reserve Bank Act, which says that the duty of the Reserve Bank board, "within the limits of its powers" (nice caveat that), is to ensure that the monetary and banking policy of the bank is "directed to the greatest advantage of the people of Australia and that the powers of the bank under this Act are exercised in such a manner as, in the opinion of the Reserve Bank board, will best contribute to: (a) the stability of the currency of Australia; (b) the maintenance of full employment in Australia; and (c) the economic prosperity and welfare of the people of Australia".

All this is literally impossible, of course, but don't tell the Treasurer as he might open some rather unpleasant cans if he becomes engaged in this debate. This will eventually occur, and no amount of revealing the man behind the mask on national television will prevent the resulting rethink.

Australia is poised with net advantage between the old world and the new world.

Industrial production has been falling and business confidence is about neutral - based on an average of those who are working flat out to service the new world and those who are struggling in competition with the new world.

Overall, employment growth has been strong, yet hours worked are still low and there are many people not counted in official figures who would like to work if they could.

Goods and services inflation is rising too fast for comfort and the latest unofficial statistics, when annualised, look rather alarming.

House prices are rising quickly, and not just in the mining states. The latest reading says house prices nationally rose 1.4 per cent in February and are up by 3.1 per cent in just the past three months.

Within this concerning overall picture, prices in Melbourne are up by 5.4 per cent in the past three months, and in Sydney by 3.8 per cent.

There has been a smaller, 2.5 per cent rise in Adelaide, but little movement in the capitals of the mining states, with prices in Brisbane up only 0.4 per cent and Perth down 0.2 per cent.

Clearly, forces other than the renewed mining boom are at play here, greatly complicating the Reserve Bank's complicated task.

When matters become too complicated, decision makers tend to grasp at the simplest credible decision rule. Goods and services inflation is up, house price inflation is up and we have interest rates below average.

Another 25 basis point hike is therefore the likely outcome, perhaps even 50 basis points, if Glenn Stevens has received instructions to that effect from on high.

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First published in The Australian on April 6, 2010.



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About the Author

Henry Thornton (1760-1815) was a banker, M.P., Philanthropist, and a leading figure in the influential group of Evangelicals that was known as the Clapham set. His column is provided by the writers at www.henrythornton.com.

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