The move by the Reserve Bank yesterday to raise interest rates by 0.25 per cent reveals a major flaw in Australian economic policy making. The rise comes the week before the Federal Budget is to be brought down. The rise happened because the Reserve Bank board’s monthly meeting happened to fall on Tuesday. Surely, the Budget should have been a factor in the setting of monetary policy? The Reserve board must have ignored the possibility of fiscal policy having any effect on inflation, or second-guessed it. Either way it is a unsatisfactory situation. The Reserve says that inflation is its primary consideration in setting interest rates. Treasurer Peter Costello has long stated that the Coalition’s fiscal responsibility has been a major factor in delivering low interest rates. The Coalition has often taken credit for lowering the burden of mortgage repayments. Yet here we have the Reserve board raising interest rates because of a fear of rising inflation without waiting to see whether the Treasurer’s Budget will have an effect on inflation. The Reserve has been premature in raising rates, unless it has assumed that the Federal Government will not be as fiscally responsible as in the past and that its Budget will have a neutral or negative effect on inflation.
Unfortunately, it is probably a fair assumption. It is likely the Budget will not help on the inflation front so the Reserve feels that it must use the blunt instrument of interest rates to attack inflation.
It is a sad indictment on Australian economic policy-making. It is a sad case of buck-passing. The Government is not doing well in the polls. It is likely that it will want to go to an election early next year (before the next Budget) because it will be hoping that some of the Olympics and centenary of Federation hoopla will rub off in a feel-good factor. So this is the last Budget to hand out goodies. Given the compromises on the GST, large defence spending on Timor and the need to soften the GST blow, the Government will not be in any condition to tighten fiscal policy. As the Government loses popularity the longer it is in office, the more it has to woo voters. Projected surpluses for 2000-01 several years ago (when they had no political significance) have been eroded with expanding outlays. Mr Costello might produce a smoke-an-mirrors surplus next week, but it will be an effective deficit. And it will come just after the top of the boom in the business cycle – at a time when significant surpluses would be more appropriate.
Inevitably, the vote-winning largesse to be provided by Mr Costello will have to be paid for. Unfortunately, it will be paid for by mortgages payers, business borrowers and the people they employ. In the short term (before the next election) the Government will escape the blame. Rather, the banks and the international economy will be held responsible.
It would have been far better if the Reserve had not raised rates. For a start, the fear of inflation was largely based upon petrol prices which have since gone down. The Reserve also cited the falling exchange rate as a reason to increase rates. It suggested that a falling Australian dollar would fuel inflation. That is not necessarily so. Sure the price of imported goods might rise, but fewer of them would be bought and more domestic products would be bought. It might have been better not to slavishly follow the US rates, but rather concentrate on the domestic market. Refusing to increase the rate might have resulted in the Treasurer understanding the need for a tighter fiscal policy rather than letting him off the hook. Also, why pander to the overseas holders of Australian dollars who would like to see a higher Australian interest rate to increase their returns. Why not be genuinely market-oriented and let the currency rise and fall with the market. Who cares if the Australian currency went to 50 cents or 40 cents, even. Australian exporters would lap it up. Australian producers would enjoy the higher price of foreign goods. Why artificially prop the currency up at the expense of Australian mortgage holders and Australian small business?
The Reserve board got it wrong.