Better late than never

There are two points that modify this argument. First, actual annual CPI inflation is artificially lower because the dropping out of the "temporary" banana price hikes a year ago. And the main items well above the artificially low overall rate were alcohol, housing, health and finance and insurance services, which is why Struggletown is doing it so hard. However, the more important point is that "underlying" goods and services inflation was 0.9 per cent for the quarter and 2.9 per cent for the year. This keeps the Reserve Bank on the hook, and adds to the rate hike case for the meeting of its board on Melbourne Cup day.

To return to our main theme of forecasting errors, another quote: "Producer prices grew by 1.1 per cent in the September quarter, well above expectations".

Further support for the forecasting bias hypothesis comes from an unexpected source. Michael Bachelard reported at the weekend for The Age that "real" (i.e inflation adjusted) pay has gone backwards under the Howard Government's new wage setting system, with some workers on award pay rates now more than $15 a week worse off in the past 12 months. (This is part of the reason for such strong employment growth, incidentally.)

Bachelard said: "Recent higher inflation has overtaken the modest pay rises handed out by the Australian Fair Pay Commission last month, pushing most of the 1 million workers covered by award rates into the red, according to new figures.

"The commission confirmed the figures yesterday, saying it had relied on Reserve Bank inflation forecasts, which were too low."

"The inflation forecast was 1.6 per cent for the period December 2006 to October 2007. We now know the actual outcome for the period was a rate of CPI inflation of 2 per cent," Commissioner Ian Harper told The Age.

It is impossible to believe the clever economists at the Reserve Bank have not noticed the clear tendency for economic outcomes to exceed expectations, and the market consensus that they do so much to shape.

The graph provides a look at 50 years of inflation, including measures of inflationary expectations of consumers. There is an opposite bias in consumers -- often their forecasts for inflation are too high. (This tendency was particularly evident after the high inflation created by the Whitlam government.) However, the hike in inflationary expectations, to an annual rate of 4.6 per cent, in October is alarming. It follows a general upward drift of all main measures of inflation since the late 1990s. The latest rise of inflationary expectations will fuel further sizeable wage claims, as we have already seem in the mining and service industries, most recently with nurses in Victoria.

A brave central bank would implement a 50-basis-point pre-emptive strike now. If there is no hike at all, the incoming government -- of whatever colour -- should think hard about the terms of its agreement with the Reserve Bank.