August 24th 2002

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Articles from this issue:

COVER STORY: Embryo experiments: are there any limits?

ALP's problems deeper than pre-selections and branch-stacking

Zimbabwe: Mugabe aggravates drought crisis

STRAWS IN THE WIND: Dizzy with success / Angry amnesiacs

EMBRYO EXPERIMENTATION: Consuming our unborn is indefensible

LAW: High Court judgment deepens native title confusion

General Cosgrove was wrong on Vietnam (letter)

Why the stock market plunged (letter)

Snowy River plan damages Murray basin (letter)

Infrastructure savings (letter)

COMMENT: Whose voice can be heard?

VICTORIA: Public forces backdown on Victorian sex zone plans

POPULATION: Time to set the record straight

COMMENT: Can the ABC be saved from itself?

ECONOMY: The Reserve, interest rates and inflation

ASIA: Taiwan's banking system under siege

BOOKS: Baby Hunger: The New Battle for Motherhood, by Sylvia Ann Hewlett

BOOKS: American Scoundrel: The Life of the Notorious Civil War General Dan Sickles, by Thomas Keneally

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The Reserve, interest rates and inflation

by Colin Teese

News Weekly, August 24, 2002
Back in the days when the people were being softened up to accept the new policies of deregulation and free trade, two arguments dominated the debate.

Apart, that is, from the crass appeal to self interest - if we gave up regulation and accepted free trade, so the argument went, then consumer goods would be cheaper, and so would our borrowings. Taken together, these two considerations would greatly improve our standards of living.

At the level of more careful consideration, the regulated economy was said to be afflicted with intractable problems. Our prosperity, we were informed solemnly, was structured around internally generated economic growth. The responsibility for increasing standards of living rested entirely upon locally generated demand.

Future growth

We were also told that this situation could not continue - though the reasons why were never made clear.

Our future growth must be linked with closer participation in the world economy. For this to happen, local institutions, from manufacturing industry to banks, had to step up the level of their competitiveness. They had to be competitive in the wider global economy - in short they must be internationally competitive.

So the deregulation of financial markets and the cutting of tariffs wasn't an option, but a necessity. Otherwise, we would be obliged to surrender some, if not all, of our prosperous lifestyle. As already mentioned, none of these assertions were supported by evidence.

Personal savings was another important issue. We were not saving nearly enough. We must save in order to ensure our future. Never mind that out of the other side of their mouths, the same experts were telling us that among the many virtues of their brand of economic organisation was cheaper consumer goods.

Is it any wonder that the more careful observers concluded that though we were being invited to enter the world of cheaper goods, its benefits were to be denied us. We were required to save, not spend, our newfound wealth. Nobody was impolite enough to ask, what, then, were the benefits of the new paradise, if consumers were prevented from enjoying its fruits?

Learned papers were produced, and reports to governments on the subject of savings. The serious newspapers were full of feature articles, all exhorting us to save. All were very clear about what was needed and how serious the economic consequences would be if the savings rate was not improved.

Of course the Reserve Bank came in behind the suggestions. However, neither the Bank, nor any of the other self-styled experts chose to share with us their ideas on how, politically, their proposals might be implemented. Which is hardly surprising, since at the very moment the proposals on savings were being advanced, deregulation of financial markets was opening up the possibility of almost unlimited, and frequently ill-advised, credit facilities - both for business and consumer use.

The Reserve Bank went further and identified another critical element in the new prosperity equation. According to the Bank, containing inflation was the key to everything. In fairness, the Reserve was not alone in this view - every central bank in the Western world was chanting the same mantra.

Guiding hand

The central banks, including ours, agreed on another proposition. The guiding hand of economic policy must be wrenched from the inappropriate hands of self-interested and pragmatically motivated politicians.

The foremost economic national interest was the containment of inflation. All efforts at making industries more competitive, and competing in the global economy, would come to nothing if inflation could not be contained.

In Australia's case only the reliably safe hands of the Governor of the Reserve Bank, and those of his advisors, could be entrusted with this important work.

Now, in case you get the wrong idea, none should be seen as passing to unelected officials the right to determine the national interest. Quite the opposite. Elected representatives, you see, in the person of the Treasurer or indeed the Prime Minister, would direct the Reserve Bank as to the economic policy direction.

It was taken for granted that such instructions would align with the accepted orthodoxy of good economic practice. And this orthodoxy would be precisely that enunciated by the Reserve Bank. Cynics might conclude that this describes perfectly a vicious circle of policy making.

Thus containing inflation became the central plank of our economic policy. There was also agreement about the means by which the Bank controlled inflation. It would manage interest rates on borrowings. Economists call this monetary policy.

We can now record that inflation, at least since the early nineties, has been well and truly contained - though at the cost of high unemployment and reduced output. Whether or not shifting interest rates has been the decisive force in achieving this outcome is another question, which, happily, we can leave to debate among economists.

What can't be denied is that the other desirable policy outcomes which were said to ride on the back of low inflation have not been realised.

Every month figures are published which are said to indicate the state of the nation's health. And they still rest upon consumption patterns in the domestic market - the growth in retail sales, motor vehicle registrations and new housing starts. Exactly as in the period before all of the so-called reforms beginning in the 80s of the last century, we look for evidence of economic health not in how we are performing internationally, but in consumer spending in the domestic market.

There is, of course, an important difference, between then and now. Twenty years ago, growth in domestic consumption was generated, in important measure, by increased local production. Now many consumer goods previously made here are imported. Which is why foreign debt continues to increase to what must surely be unsustainable levels. But that is a story for another time.

How does the Reserve Bank figure in all of this? Well, it is supposed, by its control of interest rates, to be dedicated to controlling inflation. All of the orthodox signs at this time suggest that the economy is booming and that the boom, as usual, is being sustained by consumer spending. In particular, the housing sector seems to be seriously overheated. Domestic housing is being exchanged at ever increasing prices and the Reserve Bank itself has commented unfavourably on this development.

By all the usual standards, if the Reserve is interested in low inflation, this is surely the time to be increasing interest rates in an effort to take the heat out of the economy. Certainly, financial journals have been, for some time, speculating on the timing of rate increases, given the overheated domestic economy.

Why, we may ask, has the Bank not responded to these signs? According to its Governor, the heat in the economy is acknowledged. So what about the threat of inflation? The Reserve says it is holding down interest rates because it is not yet able to discern what effect the downturn in other Western economies is going to have on Australia.

In other words he is saying that, regardless of domestic threats of inflation, international circumstances having nothing to do with inflation, could lead us into recession.

Fair enough, though the Bank has denied that very possibility in the past. By prudent management our economy was immunised against such a possibility. The Asian collapse had demonstrated that.

So has the Bank changed tack? It would appear so. The duty to control inflation no longer seems its first priority. We now have the Reserve Bank Governor telling us, in effect, that he has identified a danger more important than inflation at this time.

Very important, all of this, when we consider that the Bank asked for, and received, power to control monetary policy (interest rates) for the purpose of controlling inflation, precisely because politicians - in the pursuit of other interests - risked losing sight of the absolute need to contain inflation.

Yet by his most recent actions has not the Reserve Bank's Governor done precisely the same thing? For the moment he has put the risk of an economic downturn ahead of the need to keep a hold on inflation.

Suppose he is wrong in his judgment? Supposing there is no downturn and inflation takes off? How will he be able to defend his decision to depart from the primary purpose he has imposed upon himself? And will he not be open to the criticism that his action, however justified, is political, not economic?

Interesting times are ahead.

  • Colin Teese was Deputy Secretary of the Department of Trade

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