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We need tighter fiscal, monetary policies

By Henry Thornton - posted Tuesday, 5 October 2010

A month ago I said the Reserve Bank should, but probably would not, begin a new series of rate hikes.

This was followed by a flood of confirmatory opinion - starting with the Reserve's own statement on the day of the meeting, its subsequent Statement on Monetary Stability, the minutes of the meeting and the rapidly revised opinions of the commentariat.

The boldest of the comments was from a young man recently departed from the Reserve, where he ran one of the sections in the Economic Analysis Department. This young man boldly predicted a 25 basis point rate hike this year and four more next year. I like the cut of his jib.


But, on the other hand, no lesser an authority than the International Monetary Fund has said, in a preliminary report on Australia, the Reserve has "scope to wait for the outlook to become clearer".

No suggestion in this report of the fact that rate tightening has often been too little, too late, and that inflation was headed strongly up before the RBA's reputation was saved by the global crisis.

If I know Glenn Stevens, he will not want to be caught napping again, as he was in 2006 and 2007. For example, in August 2006, this writer said: "Too little, too late". "That, surely, is the verdict on Ian Macfarlane's Reserve. Inflation globally is on the rise and global inflation is set to rise further.

"In Australia, the economy is benefiting from a major mining boom and this is helping to produce severe shortages of skilled labour, unsustainable growth of credit and rising inflation, which has already raised inflationary expectations. All these facts are indicators of inflation yet to come."

In my delving into the history of four centuries of boom and bust, I discovered I was not the first to write of the dangers of adjusting monetary policy "too little, too late". John Clapham, author of The Bank of England, A History, says (in Volume II, p258-259) that a young George Joachim Goschen joined the Court of the Bank and produced a book called Theory of the Foreign Exchanges, published initially as an anonymous pamphlet.

Goschen advocated that, to better protect the reserves, the bank rate should be moved up not by half but rather 1 per cent at a time. This is perhaps the first time anyone criticised a central bank for moving "too little, too late" to achieve its objectives. The proposal was most unpopular at the time but was later commended by the magisterial Walter Bagehot in his book Lombard Street, when he wrote in 1873: "On this occasion, and, as far as I know, on this occasion alone the Bank of England made an excellent alteration of their policy, which was not exacted by contemporary opinion, and which was in advance of it."


So we see, the IMF is not the only source of expertise in the matter of monetary policy, or of economic policy more generally. Its weaknesses are those of any member of a cosy club, which is exactly what the league of international econocrats is these days.

The IMF also praised the government's efforts to stimulate the economy, despite the manifest waste and mismanagement.

More sensibly, the IMF commended the planned return to surplus, but warned that volatility of commodity prices showed the need for larger surpluses than previously imagined to provide the wherewithal to minimise future boom and bust.

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First published in The Australian on October 5, 2010.

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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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