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The RBA is as useful as a stopped clock

By Henry Thornton - posted Monday, 10 May 2004

The Reserve Bank today increased the Official Cash Rate from 5.25 percent to 5.5 percent.

Commenting on the decision, Reserve Bank Governor ... said: "The ... economy continues to perform strongly and this is being supported by further improvements in the global economy ... However, domestic inflation pressures remain strong and annual CPI inflation looks set to rise over the year ahead, as we projected in our March Monetary Policy Statement. Moving interest rates to less stimulatory levels appears prudent to ensure inflation remains within the target range over the medium term."

Which Reserve Bank Governor? Which economy? "Alan Bollard" and "New Zealand" are the answers. The RBNZ moved last week, on 29 April, its second such move since the start of 2004. It has a well-publicised view that a further 0.25 per cent rate hike, to 5.75 per cent, is probable in coming months.


The contrast with the Australian Reserve Bank could not be greater. Despite its staff publicly assessing that policy is still stimulative, implicitly supporting the idea of rate rises, the decision-makers that comprise the board of the Reserve Bank of Australia have sat pat on interest rates through all of 2004 so far.

But the factors driving the rate rise in New Zealand exist also in Australia, excepting that the argument for an Australian rate rise is stronger. The comparison can be clearly seen in the table of key economic statistics below. In every case, except for non-tradable goods price inflation (so far), what is happening in Australia is even more worrying than in New Zealand.

Global developments have made action more urgent.

Since the last meeting of the RBA board, the US Federal Reserve chief, Dr Alan Greenspan, has changed his tune. Deflation is no longer seen as a risk; rather it is inflation we have to fear. The World Bank and the International Monetary Fund have sharpened their warnings of global economic imbalances and, with US market interest rates rising, it seems only a matter of time before the US Fed moves its policy rate up from its current 1 per cent level, which is at least 2 per cent below normal. Indeed, one Reserve Bank board member, Warwick Mckibben, has said that the US is pursuing policies that are bound to lead to trouble. "We've got the loose monetary experience of the 1970s with its inflationary danger, together with fiscal insanity greater than in the earlier 1980s crunched up into the present." (Quoted by John Garnaut in the SMH, on 26 April 2004.)

Also the Chinese administration has begun to act to wind in its long economic boom, warning of tough action to come to reduce inflation and over-investment. Lacking the advanced nations' ability to implement an effective monetary tightening through increasing interest rates, financial markets understandably fear the blunt edge of draconian regulation of lending. Such credit squeezes used to wreak havoc in the developed world, and the immediate response in global markets has been a major set-back to hitherto booming commodity prices. The Australian dollar has suffered collateral damage in the firestorm.

But the overall picture remains one of increased global growth - with the overall pace forecast at rates that clearly cannot be sustained far into the future without major problems developing. US fiscal and monetary policies remain extremely stimulatory, and Dr Greenspan's warnings of the potential for higher rates of interest seem to be "too little too late".


In these circumstances two of the imbalances shared by Australia and New Zealand are particularly worrying. The first is the current-account deficit. At either New Zealand's 4.5 per cent of GDP or Australia's 6 per cent, both are unsustainable. The Antipodean twins have high levels of international debt. The associated debt-servicing burden is low in relation to the debt only because global interest rates are low. As rates rise, the servicing burdens will become more onerous. Unless trade deficits shrink faster than interest rates increase, the overall deficits will blow out, quite possibly to levels that precipitate a currency crisis, leading most likely to a sharp rise in domestic rates of interest.

The second major imbalance in each economy is the excessive pace of wholly domestic price rises. While overall inflation is within the "target zone' (1-3 per cent in NZ and 2-3 per cent in Australia), domestic inflation (seen in the rate of increase in prices of non-tradeables) is well above the upper edge of this comfort zone. Overall inflation has been held down in both countries by a rising exchange rate. But with rising global market interest rates, the Australian and New Zealand currencies have begun to fall. The beneficial anti-inflationary effect of a rising exchange rate in each case is now being replaced by the pro-inflationary effect of currency depreciation. In consequence, the prospective rate of inflation in both countries a year or so ahead is now well above the target range for overall inflation. And in Australia's case, we cannot be at all sure that the rate of non-tradeables inflation will cease to edge ever higher, given the pace of wage increases.

There are other imbalances not shown in this table. For instance, in both countries house prices have been rising at excessive rates, household borrowing is at an extreme and household debt is rising at rates well above what is sustainable.

Indeed, in hindsight it is no surprise that the RBNZ has again raised Kiwi interest rates. As Australia's economic imbalances are greater than those in New Zealand, the surprise ought to be that the Reserve Bank of Australia has not yet acted.

Indeed, its seems especially inappropriate that the Australian government's "no policy change" budget surplus is being vandalised in the interests of political expediency. This is not a time for fiscal largesse: it will exacerbate the problems caused by monetary ease. In contrast to Treasurer Peter Costello's gauche hints that the Reserve Bank of Australia should leave interest rates unchanged, in Henry Thornton's view the theoretically independent Reserve Bank of Australia will be as useless as a stopped clock if it fails to raise rates soon.

Latest IndicatorUnitsDateNZAus
Nominal GDPy/y %chDec Q7.17.8
Real GDPy/y %chDec Q3.24.0
Curr Acct Deficit%GDPDec Q6.16.4
Terms of Tradey/y %chDec Q6.16.4
Av Earningsy/y %chDec Q3.3
(wkly ord
CPI All Groupsy/y %chMar Q1.52.0
CPI Wted Mediany/y %chMar Q2.12.3
CPI Tradeablesy/y %chNZ-Mar Q
Aus-Dec Q
CPI Non-tradeablesy/y %chNZ-Mar Q
Aus-Dec Q
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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

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