Aussie economy powers on

The Australian economy is set to continue its strong growth. It has shrugged off a period of weakness, unemployment keeps falling, business investment is surging and consumers are spending again. Monetary policy needs to be tightened.

The graph shows US and Australian Gross Domestic Product growth. Notice how the early lead-lag relationship has become more or less simultaneous. Henry's hypothesis is that it is an aspect of globalisation - 40 years ago the US economy dominated Australia's business cycle, now both economies respond to global pressures.

Just before mid-May, global markets experienced a period of severe volatility. Resource equities and emerging market equities fell by amounts that varied from 20 per cent to almost 30 per cent. The most important reason seemed to be apparent inconsistency in new US Fed chairman Ben Bernanke's views about inflation. He started his reign as a supposed anti-inflation hawk but spoke of being "misunderstood" to an attractive lady journalist, then had to hose down the speculation created by that partial retraction.

When the dust had settled, Bernanke's concerns about inflation were clear. But, apparently, some of his Federal Open Market Committee colleagues felt he had pre-empted their decision-making and made strong speeches themselves.

The Fed's late June policy statement was softer than expected and markets rallied.

There are lessons here for the incoming Reserve Bank of Australia governor. The gossip has had deputy governor Glenn Stevens as clear favourite.

But in the second half of June, the name of Treasury Secretary Ken Henry has been mentioned as an alternative candidate.

One is led to ask why might the Treasurer be looking for an alternative to the estimable Mr Stevens?

There is always the possibility that Stevens spoke out too bravely on some policy issue, a known way for officials to limit their career prospects. It was the aggravation resulting from the Banana Republic episode as well as the excessive later tightening of monetary policy that led Paul Keating to appoint Treasury secretary Bernie Fraser as RBA governor.

There is also the obvious fact that Treasury secretaries tend to be closer to treasurers than are deputy governors. If you were treasurer and thought Glenn Stevens might be inclined to raise interest rates faster and further than Ken Henry, who would you appoint?

Also, a treasury secretary is always likely to be interested in a job he would sensibly regard as less taxing (no pun intended) and more fun - dinners in Basle have to be experienced to be believed.

We shall await the relevant announcement. Meanwhile, what has been happening in the real world? Volatile markets have eventually settled, although continued aftershocks cannot be ruled out. As the dust has settled it has become clear that global demand is still growing too strongly for comfort and that global interest rates are more likely to rise than to fall in the remainder of 2006.