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The RBA - Speaking loudly but carrying a small stick

By Nicholas Gruen - posted Monday, 7 March 2005


Until the Reserve Bank released its Statement on Monetary Policy last month I was, like most economists, predicting no change for interest rates in the next few months. Since then, almost all of us have got on board the vehicle traditionally chosen by Australian pundits for effecting rapid 180 degree changes in direction - the bandwagon.

Largely because of the Bank’s change of heart, rates have risen. But predicting rate rises is different to saying we should have them. Bond traders, who are no strangers to “groupthink” and the herd behaviour that goes with it, are surprisingly sceptical. Lots of them think a rate hike is a mistake, even though they expected it.

Having said as recently as November that there was "no pressing need" for interest rate rises, the Reserve said a couple of weeks ago that it has been debating rate rises internally, that until then it had desisted “on balance”, but that another rate rise was likely in future.

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Since then, a range of new indicators have emerged which make the Bank’s job - which cannot be done successfully without a fully functioning crystal ball - even more difficult.

You see the problem is that one set of data - the national accounts which calculates all the payments made in the economy says growth has nearly halved - from nearly 4 per cent to about 2 per cent. But the growth in the number of jobs is running at around 3 per cent per annum. Given that productivity grows at around 2 per cent per year that suggests growth around 5 per cent.

So as Rory Robertson from Macquarie Bank says, quoting Chris Caton in late 80s. “If you you’re not confused, you don’t know what’s going on”.

Further anecdotal evidence suggests looming skills shortages (lucky we cut back on education, training and research and development assistance). And the chasm between what we pay foreigners - in interest, loans and money for imports - and what they pay us for the same things is yawning ever wider. When Paul Keating famously warned of our becoming a banana republic this deficit was around 6 per cent of our economy. Last quarter it was over 7 per cent. What kind of republic does that make us now - a banana fritter republic maybe? Our economy is at serious risk of going squishy.

These numbers make further rate rises more likely - though the better policy would be a larger budget surplus and or a reordering of government spending priorities away from election bribes and towards more investment in skills, infrastructure and better incentives to move from welfare to work.

While I’m not convinced the Bank is right, they’ve got some of the best people and a great record (at least since some disastrous calls a decade and a half ago that helped give us the recession we had to have).

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I’d still offer the following caution.

US President Theodore Roosevelt practiced a brand of diplomacy he called speaking softly but carrying a big stick. The Bank is doing the converse. It's speaking loudly so it can use the smallest stick it can get away with.

The Bank will raise rates as little as it thinks is necessary because it will be acutely aware of the problem higher rates (and the resulting higher exchange rate) pose for exporters who we desperately need to thrive right now. In the past, the Bank has “jawboned” as much as it could to restrain the economy - and usually market commentators do a good job of “overshooting”. They overestimate the extent of the tightening course the RBA is on. They leave people with the impression that rates could go up a lot further than they usually do.

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First published in the Courier-Mail on March 1, 2005 before the interest rate rise as 'Rate rise of critical interest to economy'.



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About the Author

Dr Nicholas Gruen is CEO of Lateral Economics and Chairman of Peach Refund Mortgage Broker. He is working on a book entitled Reimagining Economic Reform.

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