Reserve Bank should think for itself as inflation threat looms

So far, Henry has applauded the Reserve's brisk reduction of cash rates. This is best interpreted as learning from the mistake of raising rates too slowly in the boom.

Since equity prices and commodity prices have also been falling, the RBA may also be taking account of a wider range of indicators of inflation. Their successive reports indicate as much. But the fact of all central banks cutting rates much faster than usual suggests that there is a fair amount of group-think at play here. If they bothered to comment, central bankers would deny this, preferring the label "global co-ordination".

All 18 economists surveyed by AAP last week expect the Reserve Bank to cut interest rates today. Eleven expect the cash rate to be slashed by 75 basis points, while five of the economists polled are tipping an even larger 100 basis point rate cut.

These forecasts show commendable adaptation to the faster-than-usual policy action, which itself shows a commendable response to past policy mistakes.

The key point to recall, however, is this: the Australian economy is in far better shape than those of just about all other countries.

The US news is still mostly pretty dismal, though Wall Street had a nice bounce last week.

An optimist might conclude that market participants are at the point where they think the worst of the news flow is in the market.

A pessimist is an optimist with experience.

President-elect Barack Obama has made the economy his immediate priority and has announced a stellar economic team, including Larry Summers, Tim Geithner and - the big surprise - inflation fighter Paul Volcker.

The US economy is still the most flexible around, and adjustment will be fast. There have been massive bank bailouts piled on fiscal stimulus, with more stimulus expected from the incoming president. US fiscal stimulus will create massive budget deficits and unprecedented mountains of debt, which future generations will need to service or repay. US cash rates are at 1 per cent and the Fed may have at least one more cut in its locker - some want zero.

Beyond zero there is the new concept of "quantitative easing", which is defined as the Fed exchanging private paper for Fed paper.

If pushing on a string fails, exchanging private for official paper seems to be the new monetary doctrine. How this can fail to ignite inflation is yet to be explained, but no doubt this will be tested in the laboratory that is the US economy.