Working Papers

Yes, We Have No Bananas: Anatomy of an Inflation Shock

The 1.6% quarterly and 4% through the year increase in the CPI in the June quarter will be seen cementing the case for an interest rate increase from the RBA next week.

In reality, the headline June quarter inflation number will have little to do with the reason the RBA is likely to raise interest rates.  Petrol and fruit prices together contributed one percentage point to the headline increase over the quarter, with a 250% Cyclone Larry-induced increase in banana prices the main culprit in higher fruit prices.  Strip out volatile and non-market determined prices and the CPI rose a more subdued 0.6% q/q and 2% y/y. 

What is likely to concern the RBA is the firming trend in the various measures of underlying inflation, at a time when its medium-term inflation forecast is already near the top of its 2-3% target range.  The continued run of strong activity data, including the probability the unemployment rate will post new near 30 year lows in the months ahead suggests further upside risks to the RBA’s inflation forecast.

What should concern the RBA even more is that its inflation target appears to have lost credibility with the bond market.  Yields on inflation-linked Treasury bonds have implied an inflation rate above 3% since December 2005, with the implied 10 year inflation rate having risen steadily from 1.9% back in June 2003 amid the global deflation scare of that year.  With the exception of the uncertainties surrounding the introduction of the GST in 2000, this is the first time the implied inflation rate has been above the inflation target range since 1997.

posted on 26 July 2006 by skirchner in Economics, Financial Markets

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The markets had been wondering whether CPI would breach 3.0%. Yet in just one quarter, it has (year-on-year) broken 4.0%.  It come’s despite McFarlane’s testimony just a few months ago that the next interest rate movement was as ‘likely down, as it was up’. As of next month, we will have had no less than 2 movments since this ‘monunental testimony’, with the prospect of a number more.

Parenthetically, isn’t it interesting how higher petrol prices are considered ‘one-off’ when a massively (market) undervalued yuan producing all those cheap goods, isn’t!

Also, credibility damaged is Henry, who publicly disagreed with Mc, with Henry pushing for lower interest rates, in his new-fangled ‘dash-for-growth’ mythology, which seems to translate to: “continue borrowing as much foreign money as you can, and continue spending on renovations and housing speculation”. This flim-flam is just another continuation of mythology that seems to emanate from The Australian Treasury these days, aka, J-curve theory, twin-deficits theory, new paradigm dot-com, and all the rest of the twaddle.

Now the problem. How does one reign in accelerating inflationary pressures (evident to hedge funds for a long-time) in an environment of unprecedented personal and national indebtedness, brought about by monetary hubris (ie unprecedented credit creation/ lending standard deterioration).

…these have got to be some of the most incompetent policy amateurs we’ve ever witnessed…

It may be time to pay the Pied-Piper, ie all those Asian bond-holders…

Posted by .(JavaScript must be enabled to view this email address)  on  07/27  at  09:40 AM

Do you seriously want to go back to the bad old days of credit rationing, when mortgage interest rates were set by a committee of federal cabinet?

Posted by skirchner  on  07/27  at  04:29 PM

Of course not.

I’d seriously like to go back to the pre-Hedonic index days (ie the Boskin-Greenspan banking con job). In short, I would like to ditch the US-debt stimulating CPI approach, and adopt one used by hard European and Asian currencies (ie the USD has plunged 39% against the Euro since 2000…}

I would also like to start actually including in CPI things that are treated as a consumer purchase (such as owner occupied housing). {After all, Adam Smith believed that shelter was a necessary consumable, (not much different to a car these days)}. I would also include food and energy into core inflation, and simply smooth these using a 13-term Henderson Filter. I believe these components are too important to omit.

I would seriously like to stop endogenising Asian productivity (via Hedonics), and start by conducting a monetary policy consistent with real inflation. I also don’t like the substitution allowed in the Aust and US indexes (again dis-similar to other countries}. We should target inflation, not cost of living. 

As any average economist knows, CPI understates actual INFLATION by around 50%—>


In short, I’d like the RBA to live up to its charter of price stability. Even for a necessity like shelter.


Posted by .(JavaScript must be enabled to view this email address)  on  07/31  at  12:14 PM

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