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Inflation keeps Reserve on edge

By Henry Thornton - posted Tuesday, 5 December 2006


Lending to businesses climbed 1.6 per cent, equalling the highest growth rate of the past year, while lending to consumers was substantially lower at around one half of 1 per cent.

For the year to October, total credit rose by 14.7 per cent. Lending to business grew by 16.7 per cent, while lending to households was up by around 12 per cent.

It has been argued that slower growth of household credit is a comforting statistic while the much faster growth of lending to business reflects sensible balance sheet management by businesses. The graph shows the relationship between consumer inflation and a measure of growth of the money supply.

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The imperfect correlation here involves causes running in both directions and other forces impacting on both time series.

Nevertheless we need always to keep in mind the late Milton Friedman's view that inflation is everywhere and always a monetary phenomenon. As the graph shows, both series are turning up in Australia now, an ominous sign for any responsible central banker.

There has been little news on inflation, excepting a fine paper from Tony Richards, the head of economic analysis at the Reserve.

Richards examines measures of inflation that Henry had not previously heard of, reminding him of the intricacies of modern cosmological theory.

This fine forensic exercise did not, however, shake the plain man's view that inflation is higher than it should be, and in "underlying" terms is rising to a level near the top of the Reserve's target range.

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Further, if one looks at the "25 per cent trimmed mean" measure preferred by Richards, underlying inflation is sharply up in the US and more gradually up in Euroland and Japan. Henry would be prepared to bet that such a measure would also be well up from its deflationary low in China, which as outlined last month indicates a far harder climate for containing inflation than the Reserve has faced for more than a decade.

The Melbourne Institute reported a rise in inflationary expectations of Australia's consumers, from 3.4 per cent in the year to September to 4.0 per cent in the year to October. This is another unsurprising but nevertheless worrying development.

Drought and the lagged effects of the interest rate hike so far will reduce the overall growth of the Australian economy, at least relative to what it was set to be. Whether it reduces it sufficiently to restrain inflation without further rate hikes is the great question.

No one, not even Treasurer Peter Costello or Reserve Bank governor Glenn Stevens, can be confident about the answer. There will be continued focus on the possible need to keep raising interest rates well into 2007. This will be a negative factor for the Government.

The assumption of a slower economy is plausible, and this will limit the Government's ability to offer electoral bribes or even to announce an economically responsible program of tax reform. Fortunately for the Government, however, the new Labor leader, Kevin Rudd, is not exactly well qualified to fight effectively on economic policy.

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First published in The Australian and in Henry Thornton on December 5, 2006.



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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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