If you sign a loan contract, you’re well advised to read all that boring fine print and get good advice on what the terms and conditions actually mean. This is also good advice if you plan to rely on promises from the Howard government. During the 2004 election, the Liberal’s ran on the slogan “Keeping interest rates low”. The content of this promise has now been explicated by the Prime Minister.
“You have to look at everything I said during the election campaign and you will find that I repeatedly said that interest rates would always be lower under a coalition government than Labor.
“In 13 years of Labor, housing interest rates averaged 12.75 per cent and peaked at 17. Under 10 years of coalition government, housing interest rates have averaged 7.25 per cent – a 5.5 percentage point difference.
Supposing, as looks increasingly likely, that Howard plans to stay on for another 10 years, he can manage an average rate of 17 per cent over that period and still keep his government average rate below Labor’s.
But at least Howard gets his facts straight. Treasurer Costello*, is quoted as saying
And the critical thing is to make sure that we don’t have interest rate rises of 300 per cent which would take us back to where the Labor Party low point was, or 1000 basis points, which would take us back to the height where they were under the Labor Party.”
It’s easy to check that the Labor party low point for the cash rate was 4.75 per cent in July 1993. But the message from Costello is the same as Howard’s. Anything below 17 per cent counts as delivering on the government’s promises, and anything below 9 per cent (the current cash rate of 6 per cent + 300 basis points) deserves extra applause.
* I think he’s segued from a selective quotation of home mortgage rates into discussion of the cash rate (only the latter is discussed in terms of basis points), but the implication is the same.
John Quiggin 
Interest rates are the wrong tool for the job when it comes to the impending inflation spiral. Costello was right in this regard when he recently cautioned the RBA publicly against being too quick to raise interest rates. However he has yet to point the RBA in the direction of an alternative monetary response. For the answer they should be looking at how the BOJ defeated deflation.
Neither political party has a clue. Rising oil prices are not the product of excessive Australian domestic demand. Neither are high gold prices. The problem is a weak currency. The fact that our currency is currently weak is being veiled by the fact that most of the major world currencies are currently weak.
It would be a good time to revisit the Bancor and other such ideas, even if we did so in isolation.
http://en.wikipedia.org/wiki/Bancor
The BS will only wash for so long, because unlike tampa or AWB this is one issue where voters can feel the gap between rhetoric and the whole truth in their pockets.
If a voter:
a) knows that part of the reason they voted for the Libs was the impression Howard was saying he’d keep interest rates down (irrespective of hair-splitting semantics); and
b) feels the pain that stems from the fact that (as I understand it, correct away by all means) on average people are nowing spending more of their income on repayments than at the height of the 17% spike; then
they are going to be peeved.
“nowing ” – “now”… 1 coffee detard moment, sorry.
An interest rate rise, just what I blanking well need! I wonder how much higher interest rates would be right now if Mark Latham was prime minister.
High property prices, lots of credit card debt and mortgage financing. Its going to be an interesting ride if interest rates keep going up.
Interest rates would not be different by more than 0.25 percentage points either way if Latham had won. This should be clear to anyone who’s observed the way the RBA runs monetary policy.
If there is no difference between the way Labor or Liberal would run the country, why would we ever bother to vote labor again?
perhaps because you’ve turned “interest rates would not be different” somehow magically into “there is no difference in the way they would run the country”.
I think governments do a mite bit more than macroeconomics.
> If there is no difference between the way Labor or Liberal would run the country, why would we ever bother to vote labor again?
In your case, publican Steve, so you would be able to run your own business instead of being a wage slave for the national hotel chain run by Coles and Woolworths.
“If there is no difference between the way Labor or Liberal would run the country, why would we ever bother to vote labor again?”
As someone on the left side of politics I often wonder about that too.
JQ,
Interested in your thoughts on this……
Why do need to increase interest rates because of inflationary pressures due to rising fuel prices?
Don’t rising fuel prices themselves surpress demand?
Is the RBA risking a recession by increasing rates at a time when rising fuel costs are hurting the economy?
btw…. my take on the politics of interest rates….. whether or not it is true, the average voter believes that the Coalition is a better manager of the economy than Labour – certainly all the polls show that. Howard/Costello are therefore very smart to play on interest rate concerns and run the line that interest rates will always be lower under their government than if Latham (Beazley) was in power. Voters believe that… so why not play it up? Smart politics.
I know that the slogan was eventually “Keeping interest rates low”. I cannot be sure, but I’m pretty sure I remember advertisments on TV saying “who do you trust to _keep_ interest rates at _record_ lows?”. But I cannot find a reference for this.
For the person who suggested the “Bancor”, do you think that reintroducing a gold standard will help? What if the things we have been relying on in the past have become genuinely sparser? Not much monetary policy can do there. This kind of problem requires foresight and good governance.
Does anyone know of a good link to the history of cash rates in Australia with explanations as to why they were what they were when? Keating has some argument about before Labor came to power in the ’80s they were more like 20%. Does he have a point here, or is this just some political game.
Crikey yesterday was proposing that the RBA have control of the GST rate. I can see very big upsides on this. If their mandate was to keep it long-term around 10%, it would be a far more powerful and equitable lever than mortgage rates, affecting all consumers rather than the 1/3 that have house borrowings, and having less effect on the exchange rate. Also, the extra revenue would go to the govt for expenditure on services rather than to offshore lenders.
Of course, the potential costs to small business of a fluctuating rate would be large, and it would be politically poisonous, so I can see that it would never ever happen in a zillion years.
most people who understand economics thought the budget made interest rate rises a certainty with large tax cuts without any spending cuts whilst you still have a commodity price boom.
given that the ALP economic policy was a lot more restrictive I think there is a fair argument that interest rates would be lower than under the Libs particularly since a new Government always dumps on the previous one and would have been advised by Treasury to impose a contractionary budget.
Actually my understanding is that iron Mark wanted to bring up interest rates under howard’s treasurership ( ie 90 day bank bills over 23%) but was advised by the roosters not to!
I think Howard might be disappointed that the RBA didn’t raise rates 50 points now rather than having another 25 points in November.
PrQ,
Do you think the rate rise was due to rising inflation or is there some other reason? If it is inflation, the two items that appear to have made the difference were fuel prices and bananas. Far be it from me to disagree with the RBA on their assessment of the rate, but can you really blame the government for high world crude prices and a tornado up north.
One question, though, that you may be able to answer. The fuel prices provide a possibly valid reason for raising rates – but surely bananas do not. The price has gone up so we (at least our family) have substituted other fruit for bananas.
Is the basket of goods being used for CPI calculation being adjusted to take account of this substitution effect, or is there a presumption built in that we consume as many bananas on the new price as the old?
Terje – the only reason Costello cautioned the RBA against a rate rise is because he had to stay on message – it had nothing to do with monetary policy, imho. Nothing he has done over thew last ten years provides any evidenc e that he actuallu undretands anything about the economy. His only other advice to the RBA, given its remit, would be to “put them up.” Not a goer. I’m sure the RBA took the effect of petrol rises into account, but I imagine that petrol is relatively price inelastic (ie relative to other goods in the basket) and hence people can’t substitute, which they obviously can with bananas, for example. The poor bloody RBA also has to cope with the effect of the government throwing away money like a drunken sailor – first home buyers grant, tax cuts and so on.
…in part should read..”evidence that he actually understands anything about the economy.” These mistakes always happen when my blood pressure goes up, which is pretty damn frequently these days…
The Liberals are good at sending a message and getting Labor to stay on the same message ie Labor loses the debate. The critical factor of course is not where interest rates are but how much is required to service the debts which are increasing as people maintain a lifestyle based on large borrowings.
We have a war run by the three amigos which has had a direct impact on oil prices and therefore on the cost of petrol. We have had first home grants and low interest rates encouraging people to pay more for houses than in the past. This is turn impacts on the amounts needed for council and water rates. It is possible to reduce petrol excise to reduce transport costs as the Federal Govt has a great deal held in reserve. This may become a political necessity. I predict it will happen if there is a further interest rate rise in November as has been suggested by some.
As long as Labor sings from the same song sheet as the Liberals (as Kym Beasley is all too inclined to do) people will continue to think that the Coalition are better economic managers – even as we sink under a sea of debt. It is amazing the ability of people to maintain a belief in the face of opposite evidence if it is told to them often enough.
The retail price deflator increased 1.1% in the June quarter, no petrol and the weight of bananas adjusted down to reflect the fact that no-one’s buying them.
Guess that puts an end to the bananas and fuel debate.
Finally the ALP are getting it and trying to switch the debate from focussing purely on interest rates to what really matters – the real debt repayment burden.
Heres hoping we can finally have some sensible economic debate in this country.
I seem to recall that after the last federal election, our Prime Minister was encouraging people to spend their tax cuts on plasma TVs and other such junk. A couple of 0.25% rate rises later and now the message is that there is too much debt and inflation in creeping up.
I’m not an economist, but isn’t inflation an indirect result of government monetary policy? The classic definition of inflation is “more money chasing the same amount of goods and services.� So if the government deregulates the banking industry and reduces the reserve requirements for lending, and prints more money (I’ve recently read that the current federal government has been increasing hard currency supply by 10% a year), isn’t that a big factor in what is causing inflation?
And when the PM states that interest rates will always be lower under a Liberal government than under a Labor government, little alarm bells begin ringing in my head. I have read that one of the things that the Liberal/National Coalition did when they won power in 1996 was to remove certain house price component from the CPI mix (specifically “mortgage costs� and credit charges). So what are “mortgage costs�. According to the bulletin released by the Reserve Bank in 1998:
http://www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_oct98/bu_1098_1.pdf
“mortgage costs� are the interest payed on the mortgage. The argument from the Reserve Bank seems to be that inflation in housing should not affect mortgages by feeding back into the CPI calculation. So you can remove this measure from CPI and house prices can inflate to infinity without showing up in inflation. And all based on the dubious classification that a house is not a “consumable� it is an “asset�. It seems to me to be more of a case of rubbery figures than good economic management.
It’s a bit like how economist talk about “core inflationâ€? – a measure of inflation that does not include food or petrol, or how people who work 1 hour a week are classified as employed. If you’re a low or middle income Australian (Howard’s Battlers), what percentage of your income do you spend on food and petrol? Core inflation is only important to the big end of town and the pointy-heads.
If Howard, Costello and their cronies had left mortgage costs in the CPI mix, the housing boom would not have got this out of hand. Increases in house prices and therefore mortgages costs would have lead to an increase in inflation, which would have slowed the boom down. I thought the whole justification for government (and especially the Reserve Bank) was to ensure that booms and busts did not occur. Interest rates do not need to reach 17% as Howard claims. If they reach 8-9%, Howard and Costello will be become pariahs.
You may be thinking that this is unlikely, but in the last week I’ve heard claims that rents will be going up to match the increases is interest rates. That’s good. Rent is still measured in the CPI. So please tell me what this will do to inflation.
I’m actually with Jill. Labor should be loudly pointing out that the high crude prices didn’t come from nowhere – they are a direct consequence of Bush, Blair and Howard’s utter bungling of the War on Terror.
But I reckon I know the answer – the Bomber can’t say that because,as a “national security” type he knows he personally would have followed the Yanks into this mess just as keenly as Howard. And after Mad Mark he’s not game to offend the Bushies.
Austin, the ad is this one:
Had Latham won interest rates wouldn’t be much different, as JQ says. However, Tim Colbatch (amongst others) has argued that the cause of inflation is partly because of the skills shortage and the failure to train people in areas crucial to the economy. If so, then had Labor won in 2001, and implemented Knowledge Nation (granted a big if – there was hardly unanimous support for it in their ranks) then interest rates would presumably be lower.
Is there any way of making an estimate of how much impact a higher level of training and education starting five years ago would have on interest rates today.
Of course so many of the ALP right are so interested in making Barry Jones a parahia they are unlikely to actually run this arguement.
Stephen L,
Perhaps not – but the effects of increased labour market inflexibility are easy to spot in countries wih both highly regulated labour markets and high unemployment.
Odd how they seem to go together. Also odd how the Labor Party is now very quiet on the subject of unemployment.
The logic of the existing monetary paradigm is that inflation always means too much domestic demand and higher interest rates will fix this. However one could quite logically reason that inflation was due to too little domestic supply and higher interest rates will stifle the possibility of expanding supply (via investment in new plant and equipment). Higher interest rates do in fact put “money” in some peoples pockets (roughly equal to the amount it takes out of other pockets). Although its not actually in pockets anyway, M0 determines that.
Managing the value of the national currency by reference to an internationl commodity price index (eg Bancor) does not necessitate problems if commodities become more scarce. If it happens slowly then you get a slow deflation that is mostly harmless. This is in essence what happened over the 100 years from 1800 to 1900 when the British price level halved and yet economic growth remained rapid. If it does not happen slow enough then you can always adjust the reference commodity price with time. In any case gold is not really consumed so unlike other commodities production is small anyway compared to the amount available to the market place. A gold scarsity would generally sees a steady flow of gold out of jewellery into monetary use.
The notion that a consumer price index is better than a commodity price index ignores the nature of monetary lag and inflationary price spirals. Gold was saying 12 months ago (for anybody who knew how to look) that we were headed for inflation problems if the RBA kept pumping out new currency at the same rate. Growth in M0 should have been slowed (which can be done without targeting interest rates). But the RBA is hung up on the notion that it is a bank and spends too much time (relative to other things) focused on credit markets.
I know it is largely futile but I said all this many, many months ago. I said inflation pressure was building. Some are already keen to blame this on the more recent shift in fiscal policy, which is a mistake. One that we shouldn’t be repeating.
I’ve got an idea for you Terge, how about doing some research into Japanese monetary policy, credit growth, production and consumer prices over the past six years.
The Bank of Japan might be a good place to start your enquiry.
Sdfc,
I seem to recall that I mentioned the BOJ in my first post in this thread. The monetary history of Japan over the last 15 years supports my point entirely. In fact it was formative in changing my view of monetary policy and deciding that the current paradigm is deeply flawed.
Regards,
Terje.
Smiley says ….You may be thinking that this is unlikely, but in the last week I’ve heard claims that rents will be going up to match the increases is interest rates. That’s good. Rent is still measured in the CPI. So please tell me what this will do to inflation….
Rents will go up …. yeah right – I am a mere single parent on a pensioner and mine just went up $30, while the girl next door was flattened with a $50 rent increase and she is really hurting and crying.
Of course the likes of Howard and Castrelato would never feel the same pain as we in the major suffering public do …. and we do not even eat bananas up here – even the ones they wanted to import from the Philippines (all owned and grown by Yanks on less than slave wages)
Actually it doesn’t.
Obviously I disagree. However if you elaborate and I will try and follow your reasoning.
Terje, can you point to some good references showing what happened with the BOJ that changed your views? I’m most interested, but I only have a pretty vague idea about the details. Thanks in advance.
Peter,
When I first started looking at the history of the gold standard I accepted the widespread view that it was merely a relic of history. I was previously sold on interest rates and inflation targeting as the benchmark for worlds best practice on monetary policy. I thought that New Zealand probably had the best setup to offer in terms of monetary governance and I was pleased when Australia moved to emulate it (around 1996).
I was looking at the gold standard because I was in Europe during 1997 and I became interested in discussions about the EURO and the origin of value for currencies. In currency markets it is pretty much an accepted fact that a currencies value is the result of supply and demand. Bring more currency to market and the value will fall unless there is growing demand. Reconsiling this international view of a currencies worth and the domestic view seemed to be full of gaps. In particular there is this widespread view that strong economic growth will:-
i. Make a national currency appreciate in value.
ii. Cause domestic inflation (ie a fall in the purchasing power of currency).
This situation seems to me to point to a significant flaw in the current paradigm that has been papered over but not properly addressed. Once you get into the data it is also not what the historical record shows. There is an interplay between EXPANSION/CONTRACTION and INFLATION/DEFLATION but it does not work in the manner suggested by the above contradiction.
One of the things that changed my view was the way that large changes in the gold price (and the price of any broad commodity basket) have consistently been the precursor for later shifts in consumer prices. In essence I spent a lot of time running charts of inflation and gold and commodity prices and exchange rates over expances of time for lots of countries.
For instance in the 1970s we had a rise in the US gold price (many predicted that it would fall after being “demonetized”) followed soon after by a rise in other commodity prices (eg US dollar Oil price) and then later a wage price spiral in the USA. There are many such examples form history (most nations in the 1970s but some more than others) that show that significant sustained moves in commodity prices away from the preceding medium term average is a sign of impending monetary problems.
One such example is Japan during the 1990s. The monetary deflation suffered by Japan was preceded by a sustained steady decline in the YEN price of gold. The Japanese deflation was only vanquished when the BOJ shifted from Interest rate targeting and adopted quantitative easing. After a period of quantitative easing (ie printing lots more YEN) the price of gold (in YEN) began to catch up with its ten year average. Once it did, consumer prices soon (~12-18 months) started to demonstrate that deflation had been nearly vanquished.
The situation in Japan also demonstrated the limitations of interest rate targets under certain scenerios. If the currency is constantly appreciating (deflation) then an interest rate of zero may in real terms still be quite high. And yet the nominal interest rate can’t go below zero so the real interest rate will remain positive. Central banks have some success with interest rates because their targets for inflation are positive. If they tried to target an inflation rate around 0% they would invariable fail in using an interest rate target as soon as they tipped into the deflation zone, just as Japan did for most of the 1990s (and the USA nearly did in the second half of the 1990s). However an interest rate target does work in a crude manner when your inflation target is a positive number merely by virtue of how such a target must be achieved.
The Australian dollar is now worth about 36 milligrams of gold. If you look back over the last decade that is well down on the average and has been this way for about a year. There is a lot of inertia in the price of consumer goods and it takes a long sustained spike like this before the wage price spiral gets up to speed. However once it does it drives through to inflation in consumer goods. In fact the delay means that you can fix the problem even before it shows up in consumer goods.
The following chart is a crude picture. What it lacks is a moving ten year average. In rough terms you are creating noticable monetary problems down the track if the gold price is sustained either 10% above the moving ten year average or 10% below the moving ten year average (inflation or deflation). Also with contracts for wages and rents being how they are deflation usually shows up in bankrupcy figures, lay offs and qualitative discounts (eg buy one get one free deals) long before it shows up directly in consumer prices, while inflation flows quicker to consumer prices but still after some considerable delay (~12-18 months for a step function).
There are a lot of price buffers in the supply chain (ie profit margins that ebb and flow). As such the system is like a giant car suspension system (low pass filter) that takes out the bumps and jitter in monetary errors. However just because cars have suspension systems does not mean we should build roads with lots of bumps.
It is this low pass filtering process that allows international exchange rates to be volatile (ie volatile value of currency as measured externally) whilst the domestic value of the currency can seem tranquil (as measured by internal references). However history shows that you can readily have stability on both counts. Not absolute or perfect stability but certainly trade enabling, wealth protecting, job supporting stability that is substantially better than what we have now.
In order to achieve a stable value for your currency you need to have a means of measuring value. Given that value is a relative thing the only meaningful way to measure the value of a currency is with respect to market goods. Commodities give you an instantaneous reading, consumer prices give you a filtered reading. It is like a digital speedo versus an analogue one. Both measures are of use but the former makes for a better feedback signal in a systems control sence.
Regards,
Terje.
P.S. A lot of the relevant reading and data is subscriber only. However the works of Robert Mundell offer a lot of good ground work if you don’t mind digging.
how do Australian interest rates correspond over the years and decades with those of the US and Europe? and how much are ours largely set by theirs? It seems like John Howard has had the good fortune to be prime minister during a period when Internationally interest rates have been extremely low. Does he claim his policies are responsible for low interest rates in the USA and in the event that Labour (unlikely as it seems) wins the next election that their policies would cause a sudden increase in overseas rates?
Thanks Terje. Nicely summarised. I suppose a possibe counter-argument (playing Devil’s Advocate for a aminute) is that there has been, effectively, a colossal drop in the labour cost of producing consumer goods in the last 15 years – the China/India/collapse-of-communism argument, so a rise in commodity prices is sustainable without inflation.
Further (I’m enjoying wearing these horns), the disadvantage if an instantaneous feedback signal, as compared to a low-pass-filtered signal, is that it could lead to overshoots (a “ringing” in the economy, to carry the metaphor further), whereas a a filtered feedback may lead to a more graceful tracking of cause and effect. There can’t really be a close to ideal feedback signal to steady the economic indicators because in the ecomomy there’s no such thing as an independent reference signal uncoupled to the economy itself (except perhaps long term geological and climatic forces, but they are far too “low frequency”).
Anyway, I agree with you that monetary policy is not the answer. I’ve a lot to learn.
-Peter
Peter,
The horns are fine as long as the mind is open and the brain engaged.
The feedback question is not easily resolved. I agree with the validity of your assertion however I don’t think it is correct. I do not believe the low pass filtering effect is an advantage in this instance. I am glad it occurs because it makes our lives somewhat predictable and more tolerable, however in terms of a policy signal I don’t think the CPI is the right feedback signal for the monetary policy system. I don’t think interest rates are the correct reference price in the interum either.
I did my engineering thesis on a feedback controlled reactive power generator (a virtual capacitor for power factor correction) and I think I got a pretty good feel for fast feedback, closure times and stability. I actually think that the current feedback signal causes lots of economic overshoot by being too slow. In essence that is what we see in exchange rate volatility and commodity price volatility. Go back to the gold standard era and generally (there were notable exceptions) you got stable commodity prices, stable exchange rates as well as stable consumer prices. A sea of stability. In essence if you can have your cake and eat it then why not.
One way to adopt a gold standard without throwing out the system is to keep the CPI measures for accountability but to use the gold price rather than interest rates as the interum policy setting. So for instance the RBA might target the price of the Aussie dollar at 50 milligrams of gold using open market operations. If later they think this is too tight they could revise it to 48 milligrams of gold. Such a system would allow them the freedom to adjust but ensure greater price stablity over all. Of course exhange rates would still bounce about unless other nations did a similar thing. And my assertion is that the gold price target would need adjusting very infrequently, although I would be happy to leave the RBA in charge of learning that bit for themselves.
I would also be content to have a basket of commodity prices used instead of gold as the open market operations target in the above policy formulation. Open market operations is important to understanding all of this.
http://en.wikipedia.org/wiki/Open_market_operations
Regards,
Terje.
Interest rates are at historically low levels. The Government never promised that they wouldn’t rise. They were right to stand on both their economic record of sound management and low interest rates and the ALP’s past failings.
The debt burden argument is over hyped. Deregulation allowing more competition in the lending market has allowed borrowers to increase their levels of borrowings compared to previous periods with a higher level of confidence than in the past. In the past mortgage products and other credit products were inflexible. Default rates are at all time lows. If the debt burden is so high, why then are default rates not the same as in the past?? It is the default rate that should be focussed on, not the level of debt burden.
I notice that there is a question in the census on morgage repayments. It asks how much you spend on morgage payments. Which in my case is about six times what I have to. I think the data from that question is likely to be the subject of some poor analysis and assumptions down the track.
Razor, I don’t think you understand the whole point about this issue. The measurement of inflation isn’t the same today as it was under Labor. You can’t claim that the Liberals have better economic management when you don’t even use the same yard stick. If CPI had continued to be calculated the same way it was when the interest rates were at 17%, inflation would have been roaring in 2003 (after property prices had doubled in the previous 4 years).
As I stated in my previous post, if property investors believe they can hand on increases in their mortgage repayments to their tenants, they may well be doing more damage to an already overheated economy. This will hurt not only the low income earners (as kekenidika stated), but will also have a devastating impact on the “aspirational” investors as well.
The Prime Minister might be chuffed that property prices are at record levels. But you only have to look at Japan where property prices have been falling for the last 14 years and the US where there is evidence that the property boom there is at the start of a major crisis, to realize that this may well be an illusion.
Your argument about default rates might be correct, but interest rates have only increased by 1.25% in the last 4 years (according to official figures). And as for your “deregulation” argument, wasn’t it “innovative” lending practices that brought about the 17% interest rates under Labor. I seem to remember the Pyramid Building Societies going down in Victories for this exact reason. It was way over exposed to the property market.
The problem is that you cannot just keep borrowing forever. By borrowing too much now, you are pulling future spending into the present. At some time you have to stop spending and pay off your debts. An economy based on debt is a fools economy. The government has just been playing the game of hide the inflation.
Smiley,
That is interesting – are you implying that the measure of inflation used in the 1980s included capital asset prices, such as property?
Andrew (not Reynolds) asked:
“Why do need to increase interest rates because of inflationary pressures due to rising fuel prices? Don’t rising fuel prices themselves surpress demand? Is the RBA risking a recession by increasing rates at a time when rising fuel costs are hurting the economy?”
If people were simply to accept the reduction in real income implied by a rise in the petrol price, there would be no problem. But in practice they will not – workers and capitalists will try to preserve their purchasing power, through higher wages and prices respectively, as happened in the 1970s and ’80s. An inflationary spiral is more likely to develop when the economy is close to full employment, so the RBA reduces the probability of this occurrence by cooling down the economy just a little.
There is nothing wrong with a one-off increase in the money price of bananas or petrol. This is the best way to achieve the relative price adjustments we need for a smoothly functioning price system. Price rises like this for individual goods result in general price inflation over time, but in principle this is compensated for by exchange rate adjustments, which keep us internationally competitive.
So all the RBA wants to do is prevent an isolated price-rise from precipitating a price spiral. If one wanted to go further than this, and keep the average price level constant – by means of some device like a gold standard or a fixed money supply – that would imply that when petrol and bananas become scarce, prices of some other goods would need to go down. That state of affairs can be and has been acheived, in periods of rapidly rising productivity, and where fierce competition prevails in the industries in question. But those two conditions are not always present; the rest of the time a policy to preserve a constant average price level is in effect a recipe for tight credit and high unemployment.
Terje, Japanese quantitative easing began in early 2001 however core consumer prices remained in year-on-year deflation for over another four years until after bank lending finally turned positive following years of contraction. Increasing the money supply did nothing to alleviate deflation until after the demand for credit began to recover.
Even now YOY core inflation is only 0.6% and core consumer prices again fell in Japan in June. By the way Japanese core inflation includes energy, ex-energy it was 0.2% for the year to June.
Far from spending too much time on credit markets central banks such as the Fed and RBA spend too little time focused on credit markets. After all rampant credit growth has been responsible for most of the major economic upheavals over the last 100 years or so.
By the way the Yen price of gold increased by over 60% between September 1999 and February 2003.
Andrew, I could be wrong but I think the CPI used to include mortgage repayments.
Smiley – how exactly is inflation measured differentlhy now as to when the ALP was in power?
Are you saying that current lenders are doing the same thing as the Pyramid situation? If so, how?
I thought the property market had cooled on the Eastern seaboard?
You draw a lot of very long bows, with very little evidence.
Is there really evidence in the US or just speculation (mainly by Bush haters wanting the economy to come a cropper.)?
Razor,
The CPI has been changed 13 times since it’s inception. The most significant being 1998. More info here:
http://www.abs.gov.au/Ausstats/abs@.nsf/Previousproducts/1301.0Feature%20Article332005?opendocument&tabname=Summary&prodno=1301.0&issue=2005&num=&view=
Sorry, link didn’t work
Andrew.
No, I’m implying that inflation during the 80’s had a component that measure the costs associated with mortgages (i.e. paying the interest on the loan). So the bigger the loan the bigger the costs (at the same interest rate). See the link in my original post.
Wouldn’t it be great if Tony Abbott was PM and the headlines would read “Abbott and Costello Run the Country”. Do you think John would change his name if the majority of party members thought it was a good idea?
I find it interesting that there is never much on the high rate of inflation that existed under Howard as Treasurer. What Labor did was monetarism, to ramp up the interest rates to get inflation under control by stopping the economy. In the US under Carter, there was a similar Volcker shock.
While not to such a significant extent, the same ideas underpin the rise. The entire mantra is that inflation must be kept under control at all costs and the use of the interest rate.
Crocodile,
From my reading of the linked article and the associated pages, the 1998 changes to the CPI were to broaden the scope of the basket used from those purely affecting employees to be more representative of the population as a whole.
Surely this results in it being a more accurate measure of true consumer price inflation, rather than employees, when acting as consumers price inflation.
This is a good change, making it more accurate, IMHO. Or am I missing something?
The rest of the changes were simply to keep the basket relevant. Do you think the price of dripping and tripe, important items in 1912 when the A series was first compiled, should still be there?
Andrew,
I was just wondering if you would put housing in the same classification as dripping and tripe (who knows, maybe you live in a tent)? Why does the government have the right to hide inflation in the price of the largest purchase that most Australians will ever make in their lifetimes?
If you read the bulletin that I linked to in my original post, you will see that the largest change to the CPI system in 1998 was the removal of the cost of borrowing (i.e. Mortgages, personal loans and other forms of credit such as credit cards). I wouldn’t consider these “consumerâ€? costs to be in the classification of “dripping and tripeâ€?. The argument used is that interest payed on debt should not be used to calculate the CPI as it would “feed backâ€? into the CPI calculation… Yeah, to stop people borrowing more than they could ever hope to pay back.
Why should money payed to cover interest on a mortgage not be considered the same as money payed to cover property rental? To the “consumer”, these are both considered to be the cost of putting a roof over your head.
The argument that a house is not a consumable item holds no weight (especially if it is your home). If you buy a house to live in, (as a majority of low and middle income Australians do), then it is not an asset. You don’t earn dividends from it. In fact, if you have a 20 or 30 year mortgage you will probably pay twice the amount of the initial value of the house in mortgage repayments to cover the interest and principal. When you move you will probably pay the same for an equivalent house, and you will probably have to use a reverse mortgage or down grade your home to pay for retirement and old age care.
Ok, lets say the federal government took the price of cars out of the CPI mix. Australians, could then go and take out $500,000 personal loans (if the banks would let them) to buy say Lamborghini’s or Ferrari’s and import them into Australia, without any worry of this showing up in inflation. Everyone has a luxury car and interest rates are still at 5 or 6%.
Taking housing costs out of the CPI mix is a way of giving advantage to those who can afford to invest in housing. I thought Australians liked to talk about having a fair go, not giving advantage to one group or another.
While the federal governments policy may have produced several short term booms in specific areas of the economy, in the long run that can lead to oversupply and a down-turn. That is exactly what the interest rate stick is meant to prevent. And that is exactly why interest rates were at 17% under Labor. People got too greedy and over invested in property. But this time there was no stick. Well not yet anyhow…
The CPI is also used to determine how much the government increases social security payments such as the old age pension and rent assistance. If rents start to go up then that will feed back into inflation (because rent is measured in the CPI). All the federal government has done is create an asymmetric economy. When the rest of the economy tries to catch up, watch inflation roar.
A government that tells you the truth, no mater how unpalatable, is always better than a government that will do anything and say anything to keep in power.
To answer my own question (about why mortgage costs were taken out of the CPI mix), maybe it was a cynical attempt to bribe the largest demographic in Australia – the Baby Boomers, who would have all but payed-off their mortgages. Oh look, now your houses are worth twice as much and interest rates are still low. As I said before, it is just smoke and mirrors.