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Fighting the last war?

By Henry Thornton - posted Tuesday, 1 July 2008

The economy is slowing sharply but inflationary expectations are accelerating. This is the dire dilemma facing the Reserve Bank as its board meets today.

As usual, Henry's analysis takes a long-term view. The graph (see below) shows inflation and inflationary expectations from 1959 to May this year. Versions of this graph used before have shown inflation picking up from zero in 1998, itself an ominous trend.

During Ian Macfarlane's time as governor, the warnings illustrated by this trend were ignored. Monetary policy was tightened too little, too late. The point that "too little, too late" would lead to interest rates higher than they need be was ignored.


Essentially, I believe, this was due to an inability to read the economy and its essential dynamism (confounded by an inability to take advice, freely offered, from someone with long experience in these matters).

Since Glenn Stevens has taken the reins of the Reserve, cash rates have been raised four times, once during an election campaign and two months in a row earlier this year.

The latest puff piece about Stevens, in last Friday's Australian Financial Review, labelled him "The Enforcer". Certainly he seems more on the case than his predecessor, with a lesser psychological need to be liked.

But is "The Enforcer" fighting the last war? Or has he quietly adopted Henry's advice that interest rates need not be driven too high to fight a global surge in the price of oil, foodstuffs and other commodities?

Certainly the puff piece referred to emphasises the flexibility of the Reserve in pursuing its inflation target. At this time in the economic cycle anecdotes count far more than official statistics, which necessarily provide a view obtained by a rider looking backwards.


The statistics show a clearly slowing economy. Retail sales have slowed, investment intentions have been reduced, there is one month of falling employment data, and business and household confidence is well down, in some cases to levels that in the past have signalled recession. Wages apparently remain under control. Both the ABS data for March and the wage data in the national accounts suggest wages growth with a 4 in front of it, but no run-away surge.

Against this we have an economy that in the post-World War II era has always shown great resilience and an inherent tendency to inflation. When Henry's editor left the Reserve in 1988, forced out by Paul Keating as it happens, he wrote that one of the lessons he had learned as its most senior economist was: "My conjecture is that the Australian economy is likely to show a continued tendency to grow too strongly for comfort."

Then there is the ongoing reality of the resources boom. There are plenty of backward-looking statistics to show this.

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First published in The Australian on July 1, 2008 and in Henry Thornton's blog.

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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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