Like what you've read?

On Line Opinion is the only Australian site where you get all sides of the story. We don't
charge, but we need your support. Here�s how you can help.

  • Advertise

    We have a monthly audience of 70,000 and advertising packages from $200 a month.

  • Volunteer

    We always need commissioning editors and sub-editors.

  • Contribute

    Got something to say? Submit an essay.


 The National Forum   Donate   Your Account   On Line Opinion   Forum   Blogs   Polling   About   
On Line Opinion logo ON LINE OPINION - Australia's e-journal of social and political debate

Subscribe!
Subscribe





On Line Opinion is a not-for-profit publication and relies on the generosity of its sponsors, editors and contributors. If you would like to help, contact us.
___________

Syndicate
RSS/XML


RSS 2.0

We need tighter fiscal, monetary policies

By Henry Thornton - posted Tuesday, 5 October 2010


A month ago I said the Reserve Bank should, but probably would not, begin a new series of rate hikes.

This was followed by a flood of confirmatory opinion - starting with the Reserve's own statement on the day of the meeting, its subsequent Statement on Monetary Stability, the minutes of the meeting and the rapidly revised opinions of the commentariat.

The boldest of the comments was from a young man recently departed from the Reserve, where he ran one of the sections in the Economic Analysis Department. This young man boldly predicted a 25 basis point rate hike this year and four more next year. I like the cut of his jib.

Advertisement

But, on the other hand, no lesser an authority than the International Monetary Fund has said, in a preliminary report on Australia, the Reserve has "scope to wait for the outlook to become clearer".

No suggestion in this report of the fact that rate tightening has often been too little, too late, and that inflation was headed strongly up before the RBA's reputation was saved by the global crisis.

If I know Glenn Stevens, he will not want to be caught napping again, as he was in 2006 and 2007. For example, in August 2006, this writer said: "Too little, too late". "That, surely, is the verdict on Ian Macfarlane's Reserve. Inflation globally is on the rise and global inflation is set to rise further.

"In Australia, the economy is benefiting from a major mining boom and this is helping to produce severe shortages of skilled labour, unsustainable growth of credit and rising inflation, which has already raised inflationary expectations. All these facts are indicators of inflation yet to come."

In my delving into the history of four centuries of boom and bust, I discovered I was not the first to write of the dangers of adjusting monetary policy "too little, too late". John Clapham, author of The Bank of England, A History, says (in Volume II, p258-259) that a young George Joachim Goschen joined the Court of the Bank and produced a book called Theory of the Foreign Exchanges, published initially as an anonymous pamphlet.

Goschen advocated that, to better protect the reserves, the bank rate should be moved up not by half but rather 1 per cent at a time. This is perhaps the first time anyone criticised a central bank for moving "too little, too late" to achieve its objectives. The proposal was most unpopular at the time but was later commended by the magisterial Walter Bagehot in his book Lombard Street, when he wrote in 1873: "On this occasion, and, as far as I know, on this occasion alone the Bank of England made an excellent alteration of their policy, which was not exacted by contemporary opinion, and which was in advance of it."

Advertisement

So we see, the IMF is not the only source of expertise in the matter of monetary policy, or of economic policy more generally. Its weaknesses are those of any member of a cosy club, which is exactly what the league of international econocrats is these days.

The IMF also praised the government's efforts to stimulate the economy, despite the manifest waste and mismanagement.

More sensibly, the IMF commended the planned return to surplus, but warned that volatility of commodity prices showed the need for larger surpluses than previously imagined to provide the wherewithal to minimise future boom and bust.

But what if commodity prices are stronger than now expected? In that case, the less risky approach to policy is to act on the most likely possibility, with some allowance for the consequences of surprises in different directions.

In the case of Australia's renewed mining boom, the main risks are of economic activity and therefore inflation higher than now expected. The IMF praised the Henry tax review, but said, with Blind Freddy, that it should be taken more seriously. The mining tax should be widened to tax minerals other than coal and iron ore, never mind the case to tax profits of banks, indeed all companies, at a higher rate if this is indeed the optimal way for a government to slow a boom likely to run out of control.

David Uren, who drew our attention to the IMF report last week, says the IMF would also "welcome more reliance on consumption-based taxes", such as the GST, because this would allow for the elimination of inefficient state taxes and allow for cuts in personal income taxes "that would encourage increases in labour supply and saving".

That is the most sensible part of the report, so far as this writer can judge.

The IMF, Uren suggests, believes Treasury has not done sufficient planning for a sharp fall in commodity prices, saying it should be prepared for them dropping back to their long-term average, which is barely a third of their current level.

"A sharper fall in commodity prices than currently analysed in the budget would illustrate the importance of running larger surpluses during the good times to strengthen the fiscal position," the IMF is quoted as saying.

A mining boom stronger than now assumed requires tighter fiscal and monetary policies now. If this is not provided, the main alternative is the Reserve playing catch-up after inflationary expectations have began to rise.

Last week, Wayne Swan stood by his department's forecasts that commodity prices would decline gradually, dismissing a report from Access Economics that the budget was exposed to a price collapse from a Chinese downturn as "professional pessimism". I suppose the Treasurer would describe someone who is concerned at the possibility of stronger commodity prices as a "professional optimist", or simply mad. We shall see, Mr Swan. Contact the writer if you would care to make a modest bet on the matter.

On my judgment of the risks, time's a wasting, and we actually need tighter monetary and fiscal policies now.

And while we are at it, taking tax reform seriously, including a broader and possibly higher GST, would be a great idea. Is that a whole platoon of flying pigs going past my window, I wonder?

  1. Pages:
  2. 1
  3. 2
  4. All

First published in The Australian on October 5, 2010.



Discuss in our Forums

See what other readers are saying about this article!

Click here to read & post comments.

11 posts so far.

Share this:
reddit this reddit thisbookmark with del.icio.us Del.icio.usdigg thisseed newsvineSeed NewsvineStumbleUpon StumbleUponsubmit to propellerkwoff it

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.

Other articles by this Author

All articles by Henry Thornton

Creative Commons LicenseThis work is licensed under a Creative Commons License.

Photo of Henry Thornton
Article Tools
Comment 11 comments
Print Printable version
Subscribe Subscribe
Email Email a friend
Advertisement

About Us Search Discuss Feedback Legals Privacy