Why the RBA should not raise interest rates

A further rise in cash interest rates will cause great pain to many low income families at a time of mounting mortgage stress but the Reserve Bank is only interested in economic arguments so here are three reasons why it should wait a few months.

* credit market are still brittle and exceptionally risk-averse, with the spread between the official cash rate and the rate on Australian prime residential mortgage-backed securities at 75 to 80 points, compared with a normal spread of 30 to 40 basis points;

* the Australian economy will gradually slow down of its own accord because of the wealth effect, the effects of the world economic slow-down, a higher exchange rate (reflecting larger interest rate differentials), the effects of the promised fiscal tightening in 2008/9 and the delayed effect of earlier interest rate increases (monetary policy takes about a year to impact fully on the economy and we have had three official interest rate rises in the last six months or so plus an unofficial one by financial institutions);

* many of the inflationary forces in the economy are of the cost-push rather than demand-pull variety (oil, utility prices, food etc.): they dampen demand but do not respond much to domestic monetary policy; while a rise in interest rates will reduce the risk of a wage-price cycle, that risk is really quite small in todays deregulated labour market (even allowing for the proposed Rudd Government changes).

A delay of two months will not hurt the Bank’s credibility especially if it warns that it has a bias towards higher rates.

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Bring Back CL's blog
Bring Back CL's blog
13 years ago

Fred,

Inflation is accelerating. The main people who lose from inflation are the poor.

The RBA has no option but to raise rates. They have to reduce economic activity.

It is as simple as that moreover they need to ensure that underlying inflation gets closer to 2% not 4%.

I might addd if Rudd and Sanw were totaly honest about fiscal poict then they would intorduce a horror minibudget with a surplus close to 3% of GDP not 1.5%.

That is merely politics

justin
justin
13 years ago

“many of the inflationary forces in the economy are of the cost-push rather than demand-pull variety” – this is probably the best reason why they may want to hold their fire. Yes inflation is increasing but interest rate increases only dampen demand, they do not affect the prices we pay for goods set at global prices. Rising interest rates will not bring down the petrol price or the price of groceries etc etc.

Instead the productive segment of the economy will contract in order to ameliorate the effects of a part of the economy over which we have no control. is that the way to correctly manage the situation? I doubt it. It’s like having your left foot on fire and dousing your right foot in icy water to ease the pain (and to take it even further, imagine you are a footballer who kicks right-footed, thus losing some of your ability to make a living).

Anyway, given global circumstances I think waiting a month won’t hurt. I suspect we will start to see significant slowing within the Australian economy in 3 or so months time and rate cuts will be needed.

Fred Argy
Fred Argy
13 years ago

BBCb, I believe that in the next 18 months the risk of high or accelerating inflation is small while the risk of rising unemploymnet is high. And unemployment hurts the poor a lot more than 3% inflation.

Robert Braby
Robert Braby
13 years ago

Re “cost-push” inflation:

In so far as higher food prices are a result of the drought, that represents a supply shortfall which requires corresponding demand restraint. That of course does not apply to imported products such as oil.

I am at a loss to see how utility prices can be regarded as cost-push.

Nicholas Gruen
Admin
13 years ago

Fred,

Your throwaway line ‘unemployment hurts the poor a lot more than 3% inflation’ worries me. I can’t see the point of it unless you’re suggesting some tradeoff. Of course as we know, if we let inflation drift up from 2.5% to 3.5%, then if people weren’t expecting it, there are any number of nice effects in the short and medium term (though less so nowdays as the bond market sell off would impose its own costs and disciplines). Then of course letting it drift up from 3.5% to 4.5% would bring similar benefits.

But with each move up there are long term costs. They are likely to hurt the poor at least as much as any easing up on inflation now.

Jc
Jc
13 years ago

Fred:

Maybe you could take a look at this:

The RBA’s balance monthly balance sheet.

I know these days it’s pretty unfashionable to look at such things by there seems to have been an unexplained implosion in the RBA’s (total) assets going from $136 bill in Aug to $92 bill in DEC.

I noticed this last month and has me a little concerned because that’s a huge de-leveraging of the balance sheet over 4 month period, which if combined with the shape of the yield curve (pretty negative) can be indicating an almighty slowdown. I’m inclined to agree with you, they could be tightening at exactly the wrong time and drop us over the edge.

Take a look at 1989/90. Total asset side basically remained stable with little growth and we went into recession.

What do you think? 30% drop is huge unless it can be explained. Those guys are really tightening it seems to me.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

what Nick said.

It is the poor who are disadvantaged when abssoute price rise overwhelms the relative price risis sso essential to the market sytem and also the poor again when in an inflationary environment investment goes into speculative and unrpoductive areas.