The Reserve Bank should, but almost certainly will not, tighten monetary policy following the board meeting today.
It should tighten now because the Australian economy is strengthening more quickly than it, or other analysts for that matter, believed likely. It will almost certainly not tighten now because of uncertainties in the global economy, mistaken belief that domestic inflation will remain in its target zone and because it has not prepared its support base for the next rate hike.
The global economy has been grappling with risks, as well as endemic uncertainty, all this year. There have been sovereign debt alarms, double-dip recession fears and China slowdown worries.
The US Labor Department reported Friday that companies created only 67,000 new jobs in August. That’s down from the 107,000 they created in July. And because the government laid off temporary Census workers, the economy as a whole lost 54,000 jobs. Americans are now discussing the ‘great jobs recession’. Unemployment is stuck a shade below 10 %, and 25 million Americans are out of work, with many more underemployed. Consumer and business confidence is low, and the policy debate is gridlocked between expansionists who want far more dramatic stimulus packages and conservatives who say the budget deficits and prospective deficits now projected are far too big and should be slashed.
US Fed Chief Ben Bernanke sparked a bounce in stock prices when he told us that he would do whatever it takes to promote recovery, What effectively the Fed can do must be questioned. It was Keynes, or Uncle Tom Cobbley, who said it was possible to bring a horse to water , but not to make it drink. That is why monetary policy as easy as it technically can be is replaced in the Keynesian canon by fiscal expansion when monetary policy reaches the point at which it becomes like ‘pushing on a string’. But fiscal expansion, if pushed too far, becomes like pushing on a strand of soggy spaghetti. The US has probably reached this stage and must of necessity await the natural healing that time will bring, together with the native entrepreneurial get up and go of the American people.
Greece, Portugal, Spain and even the UK were in the vanguard of Eurozone nations where global investors saw a serious chance of sovereign debt default. The hardships imposed on the Greek people, and those of other profligate peoples, was not the main concern to those who worried about sovereign debt default. Mostly it was the fear that Eurozone banks would fail, leading to another severe global credit freeze.
Tough fiscal policies have been imposed in the UK, and to varying extents in other highest deficit nations. In its conclusion to a major survey, released on September 1, the IMF said: ‘What is needed in these challenging times for fiscal policy is a steady hand, not erratic changes, a steady hand to sustain the adjustment over time and reverse the long-term fiscal trends that are currently not sustainable. The current environment of low interest rates, which has so far kept debt service payments under control in G-7 economies despite surging deficits and debt levels, provides a window of opportunity to set the adjustment process in motion. Once interest rates start to rise, the adjustment will become even more challenging’.
Late last week, new information suggested that China’s manufacturing purchasing managers’ index rose for the first time in four months. The latest GDP data shows a modest slowing in annual growth from almost 12 % to just over 10 % in the year to June. Sizeable wage increases partly reflect catch up from a period of firm control, but is also consistent with a planned shift to more robust domestic growth. So far, both retail sales and export growth remain strong. India’s growth has also been strong, with perhaps a greater inflationary threat than apparent now in China. South East Asia’s strong post-crisis growth has moderated somewhat but is still runs at rates that bode well for Australian exporters.
Overall, the three global problem areas that have been causing legitimate concern to the Reserve seems to have reached the point where the assumption of ‘continued progress’ in global recovery is a more likely best guess than disruption. This makes the state of the Australian economy the main issue that should concern the Board of the Bank.
Domestically, the two big items of news have been the closeness of the recent Federal election and the dramatic improvement in Australia’s Current Account Deficit (CAD). The robust state of Australia’s financial markets during the political crisis must mean that business expects either major party, with whatever minority support either side can muster, will deliver safe and reasonably effective government. Hard-heads, of course, have bemoaned the fact that there are no bold reform plans on the table. While this has been the case so far, in a situation of effective political dead-heat leaders or leadership groups may be tempted to offer some serious reform options. This writer’s money would be on serious tax reform, and if either party had the ability to exclude the ‘elegant algebraic constructions’ from Ken Henry’s review, it would have a useful working blueprint to consider.
So far as the short-term state of the economy is concerned, the main point is that there are signs of strength across the board – consumers are spending (if disproportionately not in the monopoly retail establishments), business investment is booming and set to strengthen further, exports are setting new records and jobs growth remains strong. Most importantly, Australia’s terms of trade look like being stronger for longer than mainstream forecasts have it, and this will put great strains on the fabric of Australia’s economy and society.
Australia will need several more rate hikes to avoid excess economic activity causing troubling inflation. There is no good reason why the Reserve Bank should not get on with its program of small tightening steps. IF it does not do so now, it will be playing catch up later.
Catch-up is, of course, the traditional game for Australia’s central bank, but perhaps it can do better now.
Published today in The Australian.
Next day's press response included this.