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Clear choice for Costello as RBA's dynamic duo jostle for the top job

By Henry Thornton - posted Tuesday, 6 December 2005


RBA board members are more likely to chat about what Santa Claus is bringing than about the complexity of Australia's tax system. More's the pity.

On last week's shenanigans, Henry Thornton favours a Senate committee vetting future board nominees. Adoption of such a well-practised American process would greatly increase the transparency of the appointment process, increase the independence of the Reserve Bank and minimise the chance of an embarrassing repeat of the Gerard affair.

In truth, Santa is still on the board. All over-borrowed Australians should be aware that this is the last Christmas that RBA Governor Ian Macfarlane will be the host. He steps down in September. Interest rates for borrowers have been kept lower than they might have been by jolly Father Ian. But next Christmas, the reins of the RBA sleigh will be in new hands. In our mind, Treasurer Peter Costello (or his successor) has a clear choice.

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He can pick Deputy Governor Glenn Stevens, dour and doughty. A tougher cookie than Macfarlane, Stevens seems to have been the chief advocate of pre-emptive action to wind back inflationary pressures. He would be very likely to mark his new territory with a couple of early rate rises, if current wage pressures persist, as we expect.

The other obvious candidate is gifted academic Professor Warwick McKibbin. McKibbin is rightly famed for his practical international policy analysis of trade, capital flows, global warming and SARS. He would presumably relate more naturally to the former Professor Ben Bernanke, the new chairman of the US Federal Reserve Board.

McKibbin's general equilibrium framework tends to suggest that what Australia does in the monetary sphere matters little, so long as our interest rates attract no more than the capital inflows necessary to finance our current account deficit.

In that, he is more like Macfarlane than Stevens, though he would - we feel sure - prefer our inflation rate to be no higher than that of our trading partners.

What happens as we move through 2006 depends not only on who is governor of the bank but also on developments in the rest of the world.

Though there are pockets of spare capacity (especially in Asia and Europe), the world remains on balance an inflationary place.

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Gold finally rising through $US500 per ounce is one sign of the pressures that are building. Other commodities are rising in price too, with copper helped along by the spectacular miscalculations of a Chinese currency trader. The welcome recent easing in the price of oil is a contrary indicator, although the main message is surely that dear oil is here to stay.

The American press has been debating whether the US Fed will soon reach the end of its tightening cycle.

"Will Santa Pause visit the Fed?" asks Nouriel Roubini of RGE Monitor. Too soon for a pause, we say. The firm economic data from the US is still fuelling inflationary pressures, as the US Fed under out-going chairman of the Board of Governors, Alan Greenspan ran monetary policy too loose for too long.

Under incoming Chairman Ben Bernanke, Santa might be prepared to drop in at the Fed next year, but only if Bernanke does move quickly to get the Fed Funds rate into non-accommodative territory. A Fed Funds rate of 5 per cent seems appropriate, perhaps 0.5 above neutral and 1.0 higher than now. That would allow the US economy to slow and generate some spare capacity, but would not lead to anything resembling a recession.

Of course, what is happening in Australia also matters to our policy settings. We can't fail to wonder about the easing in monetary conditions that has occurred since the currency was let slide, even while the terms of trade have gone on rising.

The weak currency is doing wonders for unhedged exporters and it will usefully trim the profits of importers. So business fixed investment is booming. But, more worryingly, exports are lagging, retail sales are recovering, skilled labour is in short supply, wages growth is creeping up and the current account deficit is far too large.

The recent weak employment data reflects the temporary check to activity following the March 2005 rate hike. As a lagging indicator, employment growth is very likely to recover.

When we think of the inflation and wages data to come, we shiver. The new board member, Roger Corbett of Woolworths, should explain the divergence between his claim that Woolies' prices are up only 2 per cent over the year and the 10-15 per cent increases in many like-for-like sales prices in his stores.

In the remaining months that Macfarlane remains governor, we expect belated official rate hikes, and only if forced by the market. But before end-2006 we would expect Australia to follow the Fed, having to raise by 0.5 per cent in total (two 0.25 per cent hikes, well telegraphed to the market) from the present 5.5. per cent.

The RBA board may enjoy an early Christmas lunch today, as it decides inevitably to do nothing.

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First published in The Australian on December 6, 2005. Also in Henry Thornton



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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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