Working Papers

Inflation and Monetary Policy

Regular readers will not be surprised to learn I’m in furious agreement with Don Harding:

The most egregious error occurs when people argue that the Reserve Bank has aggressively tightened monetary policy. It has done nothing of the sort. The relevant measure for assessing whether the RBA has tightened monetary policy is the real (inflation-adjusted) cash rate, which stood at 3.1 per cent in March 2005 and now stands at 3.0 per cent. The seven increases in the nominal cash rate over this period have just kept pace with inflation and do not represent a tightening of policy…

The danger is that if I am right and inflation accelerates because the RBA’s approach is too soft, then the RBA will need to move aggressively and hike rates several times.

We got the first bottom-up look at June quarter inflation today, with the release of Don Harding’s inflation gauge for April.  It was a shocker at 0.5% m/m and 4.3% y/y, the strongest annual growth rate on record for this series.  Core inflation (ex-volatile items) rose 0.5% m/m and 3.9% y/y compared to 3.3% y/y in March.  The trimmed mean, which proxies for the RBA’s preferred measures of underlying inflation, rose 0.6% m/m and 4.3% y/y compared to 3.8% y/y in March. 


posted on 05 May 2008 by skirchner in Economics, Financial Markets

(9) Comments | Permalink | Main

| More


So ... with pretty much all the inflation coming out of food and energy, and the surge in national income very tightly focussed on the resources sector, the only solution available to us is to thump everyone over the head with higher interest rates?

The RBA is not going to hurt the miners by raising rates because we all know they’ll get higher prices next month.  All they’ll achieve is a recession in the rest of the economy.

Is there a better way Stephen?  Say you were made King of Australia tomorrow, how would you reform our economy so the RBA didn’t have to hurt everyone?  Surely there is a better way to target the problem areas?

I know I keep banging on about this, but does the RBA really want to hurt debt-free, non-resources exporters with this extremely blunt instrument?

Posted by .(JavaScript must be enabled to view this email address)  on  05/05  at  03:00 PM

Yes, there is a better way, which is to augment the supply-side of the economy.  But not enough of that is being done to control inflation, so we are stuck with demand management within existing capacity constraints.

Posted by skirchner  on  05/05  at  03:35 PM

By that I assume you mean we need to increase the supply of the items that are currently fuelling inflation, namely, food, energy and housing?


There seems little hope of increasing oil production in coming years, or at least increasing it enough to meet demand coming out of the BRIC countries and oil-exporting countries.  Australia’s oil production peaked some 8 years ago and has not turned around.  There is some scope to increase gas production (at least in the short term), but as oil prices increase, demand for gas will increase.  There is plenty of coal in Australia and the world, but emissions trading and carbon taxes will raise the price of coal.


Supply of many food staples is flat or lower due to droughts in Australia and other parts of the world.  A lot of corn (maize) production in the US has been diverted to ethanol, so the available supply for food production has reduced.  And of course, demand is very strong in China, India…


We may be able to do something here by releasing more land on the outskirts of cities, and allowing higher housing density closer to city centres and transport hubs, but anything we do now won’t have any effect on supply of housing for years not months.

So, apart from housing there seems very little we can do, King of Australia or not.  Agreed?

Posted by .(JavaScript must be enabled to view this email address)  on  05/06  at  08:55 AM

Without speaking for Stephen, I think one suggestion he may have made before is the budget surplus could be used to cut marginal tax rates, which should promote an increase in labour supply, putting downward pressure on price rises.
How about reallocating family tax benefits, baby bonuses, FHOG, etc, as a reduction in marginal tax rates? The net impact on the budget could even be kept revenue neutral, but you would be encouraging people to work rather than stay at home and watch TV.

Posted by .(JavaScript must be enabled to view this email address)  on  05/06  at  11:16 AM

Ok, but if marginal tax rates are reduced without reallocating FTBs, BBs, FHOG etc then surely that is putting a whole lot more dollars into the economy chasing the same amount of products and services.  I know Stephen says this won’t be inflationary but every other economist and his dog says it will, and Wayne Swan has adopted fiscal restraint as his new religion.

Who am I to believe?

Posted by .(JavaScript must be enabled to view this email address)  on  05/06  at  12:15 PM

Rajat is correct - you can get a positive supply-side response from a revenue-neutral tax reform.  And tax cuts can always be matched by spending cuts to keep the surplus neutral for activity.  So the surplus in no sense delimits the scope of tax reform.

David’s assumption that tax cuts will be spent is false, unless people think that their future income has permanently increased.  It is more likely that consumers will treat it as a windfall to be saved.

Posted by skirchner  on  05/06  at  12:26 PM

Of course not all of the tax cuts will be spent, but not all of the tax cuts will be saved either.  If the tax cuts are not revenue neutral, that still means more dollars sloshing around the economy.

Could we increase the likelihood that more is saved by offering a tax break on saving, like the 50% CGT discount?  I believe we have a long term problem with the level of savings in Australia, so this would seem like sensible policy to me.

Posted by .(JavaScript must be enabled to view this email address)  on  05/06  at  12:45 PM

Why bother with more administratively cumbersome tax breaks when you can just increase interest rates, which should encourage saving and discourage borrowing - precisely the desired result! If exporters are doing it so hard, perhaps they could hedge their currency risk or do something else. After all, a high currency combined with full employment is a great economic outcome. It means we are enjoying a high standard of living, which should not be sacrificed for the sake of a few vested interests.

Posted by .(JavaScript must be enabled to view this email address)  on  05/06  at  12:52 PM

I agree that saving more and borrowing less is the desired result.  Is whacking non-resource exporters with interest rate hikes and a strong currency also a desired result, especially when the CAD is running at 7% plus?  Why do we get extra special attention from the RBA?  What the hell happened to the “clever country”?

I’ll forward your advice that they should “do something else” onto my employees.  Perhaps we should pay all economists in US dollars, and if they don’t like it, they should do something else.  You could hedge against currency movements by eating less, and then have you “reallocted” to more high-value activities such as driving a coal truck.

Besides, as I understand it the decline in household savings is structural and requires structural measures to correct it.

Posted by .(JavaScript must be enabled to view this email address)  on  05/06  at  01:10 PM

Post a Comment

Commenting is not available in this channel entry.

Follow insteconomics on Twitter