Relying on the Reserve Bank

Since much of recent excess demand driving inflation has been due to banks and other financial institutions excessively and irresponsibly expanding credit should the burden of fighting inflation primarily fall on Governments undertaking essential public spending and households paying off mortgages?

That's what happens when government relies on changes in Reserve Bank interest rates to combat inflation.

To discourage the Reserve from further raising rates the Government has cut into existing programs and minimised increased expenditure even in critical areas starved of funding under the Howard government, such as public hospitals, universities, public schools, public housing, scientific research and environmental programs.

Bizarrely, if these spending sacrifices on vital public services succeed in avoiding rate increases, it could encourage private sector borrowing for developments of marginal community benefit such as shopping malls.

The Government was not prepared to abandon the politically sensitive pre-election promised tax cuts or slash much of the previous government's middle-class welfare - especially the $3.5 billion annual subsidy for private health care and the generous over-formula payments to rich private schools - as an alternative to increased funding for its priority areas.

The anti-inflation reliance on interest rates also inflicts severe stress on hundreds of thousands of households paying off mortgages; and those who can't meet repayments risk losing their homes.

Yet these households are not the target of interest rate rises. Their pain is collateral damage like innocent civilians injured in a military attack. Moreover, because higher rates reduce house buying and construction more households are forced into competing for a limited supply of rental accommodation which leads to a steep rise in rents. Apart from the unintended stress this feeds into exacerbating inflation which could trigger a further rate rise.

There are other serious consequences of rate increases. If rates rise well above those in the major economies this leads to a rise in the $A which can damage many of our export and import-competing industries.

And since a rise in interest rates is a blunt and unpredictable instrument with a significant time lag, several increases can provoke a recession before the Reserve Bank can play catch-up with rate cuts.

There is an alternative.

Until bank deregulation in the mid-80s fighting inflation was not dependent on raising interest rates. The Reserve Bank determined the volume of increased lending the economy could accommodate without inflationary pressures. In times of excess demand it could direct banks to lodge with it a proportion of their deposits (the Statutory Reserve Deposits) and require cuts in credit to particular sectors and, where desirable, regions of the economy while maintaining lending to other specified sectors of government priority - such as farmers, exporters and prospective home owners -and depressed regions.

With today's increasing role of non-banking financial institutions there is a strong case for bringing the largest of these within the Reserve Bank's purview.

Government could also combat inflation through some complementary actions if it gets the interest rate elephant off its back since these actions involve increased spending.

An increased public housing program for lower and middle income groups would reduce rents - and house prices - and therefore the CPI. Such a program would produce greater certainty of a substantial and more rapid increase in housing supply than the proposed tax incentives to the private sector. The macro effects of funding rental housing through cutting into the surplus or through Government borrowing would be little different to funding through the private sector. In either case the competition for resources could be avoided by appropriate Reserve Bank credit cuts as outlined above.

A substantial increase in funding for public and other poorly funded schools, especially to increase the employability of the scholastically weakest school leavers, and for the States' TAFE colleges would contribute to reducing the shortage of skilled and semi-skilled labour while hundreds of thousands remain on unemployment benefits and many work short hours because they haven't acquired the needed skills.

Expanding affordable, quality child care would release scores of thousands of mothers into the work-force and also help overcome labour shortages.

The above two progams would reduce dependence on the current level of immigration which, over the past decade, has been the largest since the post-war migrant boom. With the exception of a relatively small number of skilled migrants filling key vacancies migrants add much more to demand than to supply and are therefore a major inflationary factor especially through their impact on house prices and rents.

The government's budgetary approach to inflation will result in the exacerbation of some of our worst social problems and obstructs a long-term solution to inflation.

Additionally the current free market in finance lending hurts the financially weakest most - such as households paying off mortgages - and the financially most powerful least - such as those firms in a market situation which enables them to pass on higher rates to customers. Surely it is time to rethink the efficacy of present policy.