Inflation dodging bullets
There’s an old story about former Federal Industry Minister John Button. It refers to his (diminutive) size, to his political dexterity and maybe his luck. Several Labor ministers were caught and drenched in a downpour. Having scrambled to cover they found Button was completely dry. He’d dodged all the raindrops.
Another not so large John Howard this time has made an art form of dodging bullets. As well as amazingly low casualties in Iraq and Timor, good luck and good judgement by Australian officials has helped dodge a string of economic bullets possible economic disasters.
It looks like we’re dodging another economic bullet higher interest rates. Last week’s release of placid September quarter inflation data means that today’s RBA announcement on rates will almost certainly be “no change”. Despite soaring fuel prices, and economists’ prior fears, prices rose just 3 percent in the last year (just within the RBA’s target band of 2-3 percent). And removing volatile items puts ‘core inflation’ at 2.5 percent bang on target. Paradoxically, fuel price rises might be helping us dodge the bullet!
Howard’s first dodged economic bullet was the 1997-98 Asian financial crisis. Fearing we’d catch the contagion, foreign investors dumped our currency. Resisting calls for higher interest rates to arrest the dollar’s slide, the Reserve Bank held its nerve and it’s faith in market forces.
It held rates, allowing the market to devalue our dollar. That gave our economy just what it needed. The lower dollar relieved pressure on exporters. And keeping interest rates low kept domestic spending running just as export demand was drying up.
In the Australian economy of the 1970s the devaluation would have seen inflation soar. But the reforms of the previous fifteen years had transformed our economy. Surging productivity growth and intensified competition reduced both costs and margins. So our reformed economy digested devaluation in textbook fashion. Bullet dodged.
New Zealand’s more hawkish Reserve Bank then celebrated by inflation ‘hawks’ as one of the world’s best and most independent central banks helped run a natural antipodean experiment. It took the opposite tack and raised rates. The result? New Zealand had a recession it didn’t have to have while our economy powered on.
Since then, the millenium bug and SARS raised the very scary spectre of the unknown, but turned out to be false alarms. (Looks like we won’t be so lucky with bird flu but then who knows?)
Then there was the ‘tech wreck’ in America. The world’s biggest economy saw its stock-market collapse with annual economic growth going from four percent to around zero. September 11 hardly helped. Soon after, a national drought weighed down our economy. Yet continuing productivity growth and economic flexibility saw our own economy chug right through the drama with the help of a solid kick along from the Reserve Bank which cut rates right through 2001 by a total of two percentage points or nearly a third from where they were.
Which brings us to today’s bullet – soaring fuel prices. So far so good. Of course there will be second round effects as fuel prices work their way into the cost of transport. Forecasters see inflation bumping along at the top of its target range for some time to come. But in some ways high fuel prices might be doing us a favour.
Remember one legacy of all those bullets we’ve been dodging has been how low the Reserve has kept interest rates. That kept consumption bubbling along while demand for our exports was low. But it also fed into a housing bubble.
So far we’ve only heard a reassuring hissing sound of the bubble deflating gradually. But as participants in asset markets often try to second-guess each other, there’s always the risk of a rush for the exit in the housing market with continuing falls. That could set off an economic downturn.
If inflation does threaten a break-out from its target band for any lengthy period, interest rates will have to rise. But it will be very difficult to judge just how much is enough without turning that hissing sound from the housing bubble into a gushing one.
So wouldn’t’ it be nice if we could hit the brakes another way? We could raise taxes or cut government spending but since its early days the government’s lost its stomach for that. Ironically, although fuel price rises have increased the CPI, if their flow-on impact on other prices (and particularly wages) is muted, they may yet turn out to have done us all and John Howard a favour.
They’re acting like a foreign tax, removing spare cash from our pockets and helping us rebalance our economic priorities just as we should be away from consumption towards investment and export growth without risking a bloodbath in house prices and the resulting recession.
Yesterday when they were racing at Flemington chances are the Reserve was dodging another bullet. But that was the last thing on our minds.