Too little, too late

“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 labor, unsustainable growth of credit and rising inflation, which has already raised inflationary expectations. All these facts are indicators of inflation yet to come.

Appropriate warnings have been issued in this column, published in this journal on the morning of every Reserve Bank board meeting since June 2002. Now the super-optimists are saying the two rate hikes so far this year will prevent more hikes later - lovely thought but very unlikely.

It is also a fact that firmer monetary policy throughout recent years would have left Australia in far better shape now.

Inflation would be lower, the exchange rate would have been higher (so fuel prices in Australia would have been lower), debt would have been lower and the economy would be more competitive. NSW and Victoria would not be condemned to the slow track, and the resource states would not be booming out of control.

The relatively soft line run by Governor Macfarlane has been widely applauded. He was working against the backdrop of low global inflation and low inflationary expectations in Australia. The legacy of “the recession we had to have”, the one that “broke the stick of inflation”, was an immense help. He had the luxury of easy calls on monetary policy, allowing strong growth of retail sales (applauded by the retailers), strong growth of debt (applauded by the bankers) and a low exchange rate (applauded by the exporters who nevertheless failed to deliver the strong external accounts that the resource boom should have delivered).

For most of the period Treasury applauded too, although at times this traditional bastion of conservative economic policy ran an even stronger pro-growth line, and opposed even minor interest rate hikes. Now, finally, it seems Treasury is seriously worried and the Treasurer has warned of tough times to come.

Late last week the European Central Bank (ECB) and the Bank of England raised interest rates by 25 basis points. This is more proof, from impeccable sources, that global inflation is on the rise. Australia, sadly, is one of the leaders.

All this adds up to a much tougher job for Governor Stevens. Glenn is a dour bloke - no handicap for a central banker - but obviously well-liked by his colleagues in the RBA and his peers in financial circles. He has been variously described as, “the bank's thinker”, “hardworking”, “conscientious”, “pragmatic”, an “architect of the RBA's current approach to monetary policy”, “a Baptist” and other good things.

Henry has no quarrel with any of these descriptions, and indeed applauds the idea, also canvassed in despatches, that Stevens has been a force for giving weight to asset booms in formulating monetary policy - asset busts of course always having been a significant factor, since at least the time of Baghot.

As “the architect” Glenn Stevens has accepted some of the praise for the good performance of the Australian economy, and equally he will have to fight hard to correct the inflationary legacy of Ian Macfarlane’s decade.

Central banking, like many other important jobs, at the end of the day depends on character. Glenn Stevens is shortly to confront his own great test of character. He is said to have for many years written the Reserve Bank’s quarterly statement on monetary policy. What does this statement tell us about his views as he takes the top job?

The Reserve Bank's summary of economic conditions and prospects could hardly be clearer. The following are the key paragraphs of the Bank's Summary Introduction. Reading the full document is well worthwhile, but these paragraphs tell the essential story.

Although the increase in the June quarter headline CPI was much larger than estimates of the underlying rate, reflecting fuel price increases and a sharp rise in the price of bananas in the wake of Cyclone Larry, it is important to abstract from temporary influences in assessing the medium-term outlook.

Overall, the Bank's assessment following receipt of the June quarter prices data was that underlying inflation would remain somewhat higher than had previously been forecast. This assessment was based on the gradual increase in underlying inflation this year, and the wider background of above-average global growth and strong domestic demand.

Taking into account the expected effect of the August policy decision, the Bank's current forecast is that underlying inflation over the next two years will be around 3 per cent. In the short term, headline CPI inflation can be expected to remain significantly higher than that, but will decline to the underlying rate when temporary factors drop out of the calculation.

In summary, the situation reviewed by the Board at its recent monthly meetings was one in which evidence of stronger domestic conditions and inflation pressures was accumulating. The global economy was maintaining its strong pace of growth, while inflation in a number of countries was rising.

In Australia, national accounts data indicated a pick-up in the pace of growth in demand and output in the early part of the year, while more recent data pointed to further strength, with business surveys reporting good conditions in the June quarter and employment posting large gains. In addition it was apparent that the household sector's demand for finance had been increasing through the first half of the year. Data on producer and consumer prices for the June quarter indicated that these domestic and international developments had been accompanied by stronger inflationary pressures.

A leading economist told Henry “they have obfuscated - failed to own up to their mistakes” and avoided saying they have a “bias for tightening”. So, despite Stevens’ proclaimed Christian values and conscientious nature, it seems there is still room for improvement in the Bank’s public utterances.

But the bigger challenge for Governor Stevens will be to confront and subdue Australia’s current inflationary pressures without unduly hurting economic growth and jobs. It is sadly the poorer members of Australian society who will suffer most, and this will worry Glenn Stevens quite a bit, as it should.