Monday, November 13, 2006

Reserve Bank Inflation Forecast

Nov 2006

The Reserve Bank of Australia's (RBA) has indicated that inflation will stay at the top of its target range for some time.


  • inflation is the increase in supply of money.
  • Money is "created" by borrowing and spending. Borrowing can be by companies, by governments and by individuals. Currently, companies and individuals are creating the most debt money. Governments are borrowing little.
  • Inflation also occurs because of some external factors. eg the increase in petrol prices; the soon-to-occur increase in farm product prices due to the effects of drought and short supplies. (think what happened to banana prices after the cyclone in Nth Qld)
  • Economies run on supply and demand. If demand is high and supplies are short, then prices increase. This is the capitalist principle so beloved by the Federal Government.
However, the RBA has also signalled that interest rates could rise again early in 2007.


It comes down to economics. Now it's a long time since I studied any economics, but I do remember the following:

  • The Reserve Bank, independently of Government, sets Monetary Policy: that is interest rates. Interest rates can be used to control inflation by restricting the growth in money supply. ie as interest rates rise, we borrow less.
  • Traditionally, Australia has had strong demand in property/housing and retail spending. This is now compounded by a rapid increase in business activity, especially in mining and minerals sectors.
  • Monetary Policy (interest rates) is a blunt instrument against inflation, because they target everyone across Australia. But not "everyone" "everywhere" needs higher interest rates: the rural and farming sector, beset by drought and bank overdraughts do not need them to curtail spending; nor do small businesses. City property investors (at least those looking for a quick buck by borrowing); and inveterate retail spenders on overseas goods, DO.
  • Successive "tax cuts" have produced more spending than the value of the tax cuts. That is, we created more money and inflation than the tax cut.
  • The Federal Government sets Fiscal Policy: this is how the Federal Budget is designed to help adjust the supply and demand side of the economy. It can do this by adjusting the levels of Government borrowings, spending and by adjusting the amount of money in the economy through tax policy.

Recent tax (fiscal) policy has been to dump billions of dollars into the economy, knowing that personal spenders would increase the amount of money in the economy by more than the tax cuts. No wonder we are bordering on an inflation problem. No wonder the last 8 movements in interest rates have been interest rate rises.

Interest Rates must change when fiscal policy is deficient or unable to cope with the current economic climate.

Perhaps the Federal Government's economic management has not been quite as good as they would have us believe!

The Analyst