Brave RBA should raise rates

The graph and table shows how the Australian dollar has behaved (relative to the US dollar) since its float in 1983. Note the considerable volatility. Note, too, the possibility of a significant change of trend. Last time I showed this graph (in June 2006) the best interpretation was that it demonstrated the continuation of a century-long depreciation against the mighty greenback.

Now it seems the trend may be rising. This is a sign that, relative to the mighty US economy, our economic performance is improving, just as it sagged for a century or more - actually since the last great resource boom in the 1880s. The floating exchange rate is vital as (if coupled with a strong enough monetary policy) it allows Australia to largely avoid the contagion of global inflation. I say "largely" for two reasons. The first is that Australia's independent central bankers can only press so hard, and their theoretical power to isolate Australia from world inflation is limited by cultural and economic reality. The second point is more technical. We just do not understand the dynamics of how economies interact.

Clearly, even with a floating exchange rate, a boom or bust in US equity markets has strong echoes here. Asset markets are not totally decoupled, and cannot be. But it is interesting that moves in Australian equity prices have outperformed US markets. This is further confirmation the Australian economy is doing better than the US economy.

What should the Reserve Bank board decide today? Simply, it is to press as hard as it dares to keep Australia's economy out-performing the mighty US economy. Global inflation is on the rise. If the Reserve dares to keep Australian monetary policy tight enough to contain domestic demand, now clearly running too strongly for comfort, it will be doing most Australians a good turn.

I fear the RBA will not be brave enough. I urge Glenn Stevens during his board meeting today to remember the "almost insatiable" demand for flat screen TVs.