April 06, 2005 | Graham

RBA makes right decision

Two of my best friends (Henry Thorntonand Nicholas Gruen) don’t agree with me but the RBA made the right decision in leaving the cash rate target alone.
They might be market economists, but they don’t have faith that the market alone can get it right. I’m a little more generous. Particularly as I think the economic world in which they cut their teeth (particularly that old codger Henry Thornton) has changed significantly.
30 years ago the economy was heavily controlled and regulated and it was possible for businesses to just push rising costs onto customers. In some areas of the economy that is still true, but not in as many as it used to be. That’s because floating the dollar, lowering tariffs and decentralising the wages system gave us a much more efficient market than we had before. That makes heavy handed fiddling unnecessary.
The RBA’s power to set interest rates is similar to Saudi Arabia’s power to set the price of oil. As the most creditworthy participant in lending markets the price it is prepared to pay to borrow tends to set the price that other participants accept or charge. Except that, in a world where the market is working pretty well, that price shouldn’t be noticeably different by more than a few percentage points from the price everyone else pays.
In other words, in the modern world the RBA should act as a price follower rather than a price-setter. The only instance when it should act outside the market parameters is when the market has gone dramatically off the rails.
There are no signs of that at the moment. Sure labour is getting more expensive, and so it should, that’s a sign of increasing productivity and living standards, but there is a huge reservoir of employable and under-emplyed, so we’re not running a really tight labour market. And if we were and as a result wages became uncompetitive, many of those jobs would just move overseas to a country with a lower rate of pay, thus increasing the reservoir and acting downwards on pay rates.
The housing boom has come off the boil. There is still a lot of lending for investment, but those investors either know what they are doing, or are going to burn their fingers. Either way I don’t think it will cause inflation.
Oil price rises, another reason touted for interfering, in themselves will tend to depress economic activity, not increase inflation. There is no point reliving the nightmares of the ’70s when oil price rises caused inflation because as I said before, there is now limited capacity for businesses to pass on price rises, or for employees to claim pay rises to meet the additional cost. Times change. In fact, given the huge percentage of oil that is government taxes, oil price rises equate to a fiscal tightening.
Much of the economic boom of the last few years has been driven by increased borrowing secured against a suddenly more valuable asset base of domestic housing. There is only so much puff to that sort of expansion. With the kids’ inheritance now spent, much of the domestic economy is naturally starting to slow, and the oil price rise will exacerbate this. Those parts of the economy that will continue to go gangbusters will be to do with resources and exports, but there is no need to rein them in. Given the current account deficit there is every reason to ensure that they can continue to borrow at a reasonable price so as to fuel their needed expansion.

Posted by Graham at 1:10 pm | Comments (4) |
Filed under: Uncategorized


  1. Gruen on economic policy

    We are at what economists call the turning point of an economic cycle. Hence the need to match economic policies…

    Comment by Public Opinion — April 6, 2005 @ 2:56 pm

  2. Interest rates and Tax (and hitting the road)

    “This non-rise seems to have generated as much controversy as a rise
    would have, although perhaps with less heat. My gut feeling is that this
    diversity of views reflects the uncertainty and apprehension people are

    Comment by Senator Andrew Bartlett — April 6, 2005 @ 5:48 pm

  3. I do agree with you – what gave you the impression I don’t.
    In the week of the announcement I put out a press release which said – amongst other things “The property market is taking a breather, so I think the Reserve Bank will take one too. It certainly should.”
    “I’m a big admirer of the Bank’s restraint and good judgement on these things, and be surprised and disappointed if they don’t give themselves more time.”
    “The Bank is worried about the skill shortage and it is probably right. But if we do need to tighten, it’s unlikely we’ll need to raise rates more than another half to three quarters of a percent. So at a time of great uncertainty – both in how the economy is changing and even in which numbers to believe (the anemic GDP figures or the bullish job growth figures?) – there’s plenty of time to wait.
    So there!
    As for the RBA not setting short rates – doesn’t sound like much of an idea to me. Private money anyone?

    Comment by Nicholas Gruen — April 7, 2005 @ 7:33 pm

  4. Sorry Nicholas. Probably got confused because you were advocating some intervention in the economy via increased super contributions. I think I inferred it from the last two pars of your last article – http://www.onlineopinion.com.au/view.asp?article=3312. Re-reading it you weren’t actually accepting of the RBA position.
    On the private money front, I’ve never been able to see the real difference between the way we create credit these days and a private currency, but in these matters I have no formal training.

    Comment by Graham Young — April 7, 2005 @ 10:56 pm

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