The Reserve Bank has sensibly keep its hand off the interest-rate lever, at least for the next month. It was sensible on several grounds. It indicated a refusal to be panicked by the fall in the Australian dollar. It showed that inflation and wages are more important indicators of whether interest rates should go up than either international factors or demand. The Reserve accepted that interest rates will not be very effective against an international mood against the currency that is based on more fundamental factors than a raw return on cash investment. The Reserve appears also to have accepted that raising interest rates is a very blunt and indiscriminate instrument indeed when it comes to dampening pent up demand. It hits business investment more quickly with harsher outcomes than it hits consumer spending. Consumers’ propensity to borrow is more a function of availability of loans than the interest rate paid. A further quarter per cent will not deter many consumers.
The international mood against the Australian currency is probably wrong and will self-correct in time as international investors seize otherwise lost opportunities. Moreover, the mood is as much for the US currency as against the Australian currency. The US is sucking in huge amounts of investment because high-technology stocks are still flavour of the month and the US is the place you go to invest in them. There is a perception that Australia is an old resource economy. But that is an ignorant currency-dealing-room cliché. It misunderstands the nature of the resource economy. The cliché perception is that you dig some raw material out of the ground or grow something and ship it overseas. The fact is that there is a huge amount of innovative high-technology involved in industries like mining, wine-making or even crop growing. It is trite to divide economies into “”new” and “”old” purely on the basis of WHAT is being produced (ore or microchips). It is more significant to ask HOW it is being produced (manual labour or robotics).
The Reserve and the Government should not concern itself too much with the falling currency. In some respects they should welcome it. It will result in imports costing consumers more so they will shy away from them. Price is a more effective weapon than interest rates in dampening consumer demand. True, higher import costs will also affect businesses that import raw materials, machinery, intellectual property and other business inputs, but at least exported outputs get a benefit. This is unlike the interest-rate weapon which has no redeeming features for business investment. The Reserve is right to be reluctant to raise interest rates. The lesson of the early 1990s must be that the danger of using interest rate rises can outweigh any benefit.
At present the indications in Australia are that there is no sign of a major wage blow-out nor is there any sign that inflation will spiral beyond a one-off spike created by the GST.
The major concern in the environment of a low dollar must be the balance of trade. The imbalance has to be made up with capital investment. That has been the historical position in Australia. But capital is preferring other destinations. In this environment it is important that the Government look after fundamentals. This is why Treasurer Peter Costello was right to hold on to the bigger-than-expected surplus and not bow to populist demand to lower the petrol excise. The higher excise has the added advantage of encouraging conservation and efficiency.