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Reserve Bank should think for itself as inflation threat looms

By Henry Thornton - posted Tuesday, 2 December 2008

The Reserve Bank of Australia is expected to cut interest rates again today, perhaps by as much as 100 basis points.

Keynes famously said there were conditions in which easing monetary policy was like "pushing on a string".

We know that tightening monetary policy can slow or stop the economy and therefore, eventually, slow or stop inflation. We know that inflation is an insidious cancer that destroys economies. Yet the destruction takes time and its effects are usually not noticed until it is too late to stop inflation without severely damaging economic activity.


Having allowed the global economy to overheat, and thus generate inflation, including severe asset inflation and boomtime commodity inflation, central banks applied the brakes just as the asset and commodity bubbles were beginning to correct themselves.

Easy money in the early years of this century fuelled inflation, and monetary tightening was too little, too late.

In fact, delayed tightening usually means rates rise further than they needed to, as happened in Australia. Markets overshoot, and so do central bankers.

The Reserve Bank of Australia was not the worst offender - the Zimbabwean authorities deserve that dubious distinction, and among serious nations, the Federal Reserve Board of the US stands out.

But the Reserve Bank went along with the generally accepted doctrine of gradualism in tightening monetary policy.

There was another mistaken doctrine among central banks. The idea of "inflation" targeting was, and remains, sound. But goods and services inflation of relevance to consumers was too narrow a target. For the past decade, this measure was artificially held down by the emergence of China and India as leading industrial and trading nations.


So central banks responded too slowly to a misleading indicator.

This perhaps demonstrates that central banks may be given "independence" from political government. But independence from the group-think of the golden legion of central bankers is harder to achieve.

The point of recapping the recent history of central banking is to make a plea for more independent thinking in battling current economic problems.

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First published in The Australian on December 2, 2008.

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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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