Emergency is over, but no rate rise for Christmas

Australia’s inflation is higher than the Reserve Bank's target range and will not subside to that level without further monetary tightening - removing "emergency" ease, actually.

This conclusion applies to underlying goods and service inflation but is greatly strengthened if one factors in asset inflation. House prices are rising too strongly for comfort, and until late last week equity prices were rising sharply also.

This is the case for another cautious 25-basis-point rate hike today.

What is the case against a pre-Christmas rate hike? In decreasing order of importance, there are three major arguments.

One, the US economy is still shedding jobs. US Fed chief Ben Bernanke has sought to reassure us all that recovery is in the pipeline, but (we are entitled to say) not so you'd notice.

The US economy has shed eight million jobs since the great crash of 2008. The rate of loss has slowed, to a mere 190,000 in October, but the rate of unemployment was estimated at 10.2 per cent.

Hours worked are well down, and unemployment, underemployment and fear of one of these conditions is keeping US consumers cautious.

Then there is the US budgetary crisis. The Great Crash and its alleviation have produced trillion-dollar deficits as far as the eye can see.

The worst may be over for emergency bailouts of financial institutions, but recession-busting spending and loss of tax revenue has destabilised the US budget.

Fixing this will require either a much stronger than expected economy, massive spending cuts, tax increases or all of the above.

The second and third measures are within the US government's power to do, but by their nature will depress overall demand in the economy. Fix the budget gradually is the theoretical answer (as the economy recovers), but this is far easier said than done.

The US dollar has fallen a good way, and Chinese Treasury note and bond holders are clearly nervous about the actual and projected value of their large US dollar assets.

Extreme monetary ease also has to be removed (as private economic activity recovers) to head off the threat of inflation that all serious analysts forsee.

In fact, if one thinks sufficiently hard and long about the re-entry (to normal fiscal and monetary policies) problem, one is liable to question whether this can be achieved without a burst of damaging inflation or a relapse in real economic activity.

Do not get too rattled, gentle readers, there's more.

Global imbalances are the third major uncertainty.

Put simply, Asia has to spend more while the US and Europe needs to spend less - and required adjustments are large. All this is supposed to happen while the world adjusts to a greenhouse-gas-emission-free future.

It is worth noting that Europe generally is in roughly the same situation as the US economy, with high and still rising unemployment, budget deficits that are far too big and "emergency" low interest rates that need to be raised substantially to reduce the threat of inflation without (in their dreams) stifling economic recovery.

Against this generally gloomy background, Dubai Inc has requested a six-month debt repayment standstill, sending tremors through the world's equity markets and raising market rates of interest. The big fear, of course, is that there are far bigger embattled debtors yet to fall out of the trees, raising renewed fears about global financial system stability.

Compared with the diabolical global dilemmas, Australia's situation is almost heavenly. It is possible that official unemployment has already peaked, although hours worked are down and many full-time jobs have been replaced by part-time jobs.

There are two explanations for the relatively buoyant state of Australian labour markets, including remarkably subdued wage inflation.

First, actual unemployment and underemployment is far larger than estimated in the official statistics.

Second, firms have held on to valued workers, in some cases obtaining a quid pro quo by cutting hours of work and/or pay without an industrial relations backlash.

Australia's prospective budget deficits are more manageable than those of other developed nations. And economic recovery faster than now expected may reduce the need for the government spending cuts and/or tax hikes that will bedevil other developed nations.

Australia is of course a developed nation whose consumer spending should fall in relation to income, and hence we are on the wrong side of the imbalances divide. But with the amazingly rapid recovery of Chinese growth, the renewed resource boom will underpin Australian activity and provide time to adjust.

Higher taxes will include a resource rent tax and, one assumes, some sort of pollution tax, although the diabolical climate change problem is wreaking havoc on Australia's more conservative political party.

As argued powerfully by several participants at the recent Melbourne Institute-The Australian conference, a strategy is needed to ensure that we don't simply waste the renewed resource boom but use it to improve substantially national investment and productivity, boost savings (to help contain inflation and the current account deficit) and fund adjustment to a low-carbon future.

Easier said than done, comrades, but the sooner we can agree on a viable plan the better will be the outcome for our children and grandchildren.

There is a massive agenda ahead of the nation. Glenn Stevens' task is to make sure inflation remains under control whatever the global risks and uncertainties and the pain of domestic adjustment.

Ideally, interest rates would be nearer to neutral now, ready to be raised if inflation (defined broadly) shows signs of breaking out.

Today, I expect caution to prevail. Global uncertainties are greater than they were a month ago, asset inflation has taken a hit following a renewed debt scare and goods and services inflation here is no worse.

Besides, no one wants to wreck Christmas, and Stevens is no Grinch.