THE ECONOMY: by Patrick J. ByrneNews Weekly
Higher interest rates the wrong way to cut inflation
, March 15, 2008
Cutting government expenditure by about $30 billion would be the most effective and direct way to cut inflation rather than raising interest rates and inflicting mortgage stress on home-owners, writes Patrick J. Byrne.The Reserve Bank of Australia (RBA) has raised interest rates for the 12th time since May 2002. The early rises were a rebound after interest rates were slashed to record low levels worldwide, following the bursting of the dot.com bubble in 2000.
However, the last five or six rate rises since late 2006 have seen the RBA step in after the federal government had failed to act to curb inflationary pressures.
Inflation can be a tricky and nasty beast. If it is allowed to increase to a level where it cuts deeply into the family budget, then it can trigger a wages-prices upward spiral, which is difficult to break for both economic and political reasons. While there are some wage pressures contributing to inflation, these have lagged well behind cost pressures that have been burdening families increasingly over several years.
How to handle inflation before it gets to the wages-prices spiral stage depends on its causes. If inflation was largely caused by rising consumer demand, then a rise in interest rate would be one of several logical solutions. Requiring wage-earners to put more of their income into superannuation rather than spending it on consumption would be another sensible solution.
However, Australia has other factors driving up inflation. Consequently, the Howard and Rudd governments have got it wrong in leaving it to the RBA to fight inflation with higher interest rates.
The mining boom has caused some increase in consumer demand, but, according to the Business Council of Australia, it has also brought an $87 billion windfall to the federal government, much of which the government has spent, driving up inflation.
With recently negotiated huge increases in the price of minerals, especially coal and iron ore, the federal government is about to receive even bigger annual windfalls over the next few years.
The federal and state governments have increased a range of fees, taxes and charges that have forced up inflation; and the federal government has failed to curb price rises in areas of the economy where it has considerable influence. For example, it has allowed health funds to push up private health insurance by about 8 per cent per annum over about five years.
Further, inflationary pressures have come from price rises in the most uncompetitive areas of the economy. Oil companies and supermarkets have used their enormous market power to price-gouge. For example, supermarkets have used the pretext of the drought to drive up prices way beyond any increase in prices at the farm-gate or from processors. Governments have failed to bring about genuine competition in these sectors.
As inflation indices have indicated that these are the primary causes of Australia's inflation, then each require specific solutions.
The federal government should be announcing a $30 billion cut in government expenditure. These cuts and the unspent revenue from the mining boom should be saved. When inflation pressures come down, these savings should be used to fund a national infrastructure bank to rebuild the nation's ailing infrastructure.
Then the federal and state governments need to curb increases in government charges, fees and taxes, and they need to put the brakes on overcharging by institutions over which they have some influence, such as health funds.
By calling in treasury officials and announcing these measures, Mr Rudd would be sending a clear signal to the Reserve Bank that the government is using fiscal policies to cut inflation. Hence, there would be no need to raise interest rates.
Further, the federal government must have the political will to enforce competition in key areas of the economy, such as supermarkets and the fuel market. (See a comprehensive outline of the changes needed on pages 7-8).
To overcome the skills crisis, which is pushing up wages in some sectors, there needs to be an expansion of skills-training facilities. For similar reasons, the caps on certain university courses need to be lifted to overcome the even worse shortage of professionals.
Failure to act swiftly on these fiscal and structural issues could be substantial, as the RBA steps in instead to force up rates.
High interest rates hurt wage-earners, small businesses and farmers. High rates will bring more mortgage stress to home-buyers and curb home-building at a time when Australia is facing a major housing shortage.
In short, government inaction will see families hit by higher interest rates, on top of higher fuel, food and rental costs.- Patrick J. Byrne