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Money explosion to blame for inflation

By Henry Thornton - posted Tuesday, 5 February 2008


The first is that conditions internationally are dangerous.

Even if "dangerous" can be ruled out, the slowing of global growth now generally predicted - most recently by the International Monetary Fund (IMF) - will slow the Australian economy without further rate hikes.

Note that the IMF's latest forecast for global growth of 4.1 per cent is still a very high rate of growth, almost certainly still above the world economy's non-inflationary rate of growth.

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I note also that if the global economy were to slow to the extent that global inflation was again less than Australia's 3 per cent plus rate, the need for Australia to reduce its inflation would be even greater than seems likely now. Retaining Australia's international competitiveness is a major reason for keeping Australian inflation relatively low.

Of course, there could be some financial disaster lurking about, such as the collapse of a global bank or a geopolitical crisis that sends the price of oil through the roof sufficient to trigger a severe global recession.

In fact, if the Reserve does not raise interest rates today, readers would be entitled to assume they know more than the rest of us, including the IMF. The appropriate response if that were the case would be to go even deeper into one's economic bunker.

The second reason advanced for not raising interest rates would be that the Government's actions will do the job, and that interest rate hikes would amount to overkill.

The Government's proposed actions include a somewhat tougher fiscal policy and actions to raise efficiency and increase skills in the Australian economy.

On fiscal policy, I very much doubt that even a strong government in its first year could produce sufficient tightening to make a difference to inflation in the next year or so. Perhaps through Herculean efforts the budget surplus may be raised to 2 per cent of GDP. This would have nowhere near the impact of the Menzies government's credit squeeze in 1960, which was the last time a tough budget produced a quick, marked reduction of inflation.

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The other policies are all worthwhile and if implemented well will help Australia in the next decade, especially in its second half. But they will have none but a psychological benefit in the next year or so.

There is also the likely impact of Labor's industrial relations policies.

Under the previous government, liberal use of special immigration visas for "skilled" workers plus WorkChoices had noticeable effects in restraining labour costs and increasing growth of jobs. Partly because of these effects, there is pent-up demand for wage hikes. One must ask whether the Rudd Government will be able to restrain wage hikes despite IR "rollback".

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First published in The Australian on February 5, 2008 and on Henry Thornton’s blog.



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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 www.henrythornton.com.

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