By Michael Pascoe
One little Reserve Bank monetary statement and suddenly it seems everyone is tipping that Glenn Stevens will lift interest rates next month – but the RBA shouldn't and quite possibly won't.
It's easy to talk about "tighter monetary policy" restraining inflation, but few pause to think how it actually works.
There's the usual euphemism about higher interest rates taking money out of consumers' pockets and thereby reducing the demand their spending creates, which results in prices not rising as much as they otherwise might.
The reality is harsher.
It doesn't just mean the minority of Australians with mortgages have less to spend. Higher interest rates reduce demand by sending marginal businesses broke and making others marginal.
"Freeing up resources" when we start running close to capacity means creating unemployment in those industries that aren't riding high commodities prices or servicing those that are.
"Freeing up resources" means people going bankrupt, losing their homes and therefore forced to look further afield for work.
An immediate example that comes to mind would be higher rates sending a struggling new car dealer broke, "freeing up the resource" of the yard's mechanics who could then be expected to become available for work in the mines. It's more than a little absurd that Treasurer Wayne Swan tomorrow night will work directly against that aim with a dopey $5000 subsidy for successful small businesses to buy a new car. The offer is of no use to any business "doing it tough" as they must first have the spare capital to blow on a new vehicle which will depreciate by nearly as much as the subsidy as soon as it leaves the showroom. Tell me again how this was meant to be a tough budget.
Hawkish stance
The rush of hawkish monetary blood is based on the RBA quite suddenly increasing its inflation forecast. Last week's statement on monetary policy predicted that, if the RBA just increases rates by a quarter of a per cent later this year and by another quarter per cent sometime in 2012, underlying inflation would jump from just 2.5 per cent in the year to June 30 to 3 per cent in the year to December 31 and stay at that level until 2013 when it would rise to 3.25 per cent.
That's a sudden and surprising lift in expected inflation – one that might be based on the central bankers' memory of what started happening from about this time in 2006.
As your columnist suggested yesterday, there are dangerous parallels between May 2006 and May 2011 in strengthening commodities, falling unemployment rates and rising interest rates.
What might really worry the RBA is that steadily tightening the screws until the variable home loan rate reached 9.6 per cent didn't solve the problem – instead, the GFC saved Australia.
Pain, little gain
Similarly, starting to lift rates next month would cause plenty of pain for little gain. The inflationary pressure, as the RBA details, is coming mainly from the capex and resources booms that won't be faltered by a handful of Australian rate increases.
A stronger resources rent tax might have eased a little pressure, but that horse has long gone. A carbon tax also might – just don't tell anyone that it is policy to shed jobs in some industries to help others.
The cost of money is not a restraint to the mega-projects that are promising the nation so much extra wealth. Another 100 points or so won't halt any of the multibillion-dollar LNG schemes or iron ore or coalmine expansions. The terms of trade and capex explosion will still push record amounts of money into the obvious industries.
The RBA knows that. It's only too well aware of what a blunt instrument monetary policy is but, contrary to the text books, it's not the bank's only tool – there's also the jawbone.
The Martin Place mandarins would prefer to frighten us into behaving than bludgeon us into submission. The longer the RBA can keep consumers wary and nervous, maintain the present record level of household saving and debt reduction, the longer it can leave its interest rate club leaning against the wall.
Tabloid jolt
There was nothing new last week in the RBA saying it would have to increase interest rates – it's been a constant refrain for anyone who wanted to listen – but the sudden spin of urgency, interpreted by the commentariat as meaning many more rate rises and sooner, is a little odd.
It certainly provided a tabloid jolt and just before Swan's less-than-genuinely-tough budget.
And there remains the third policy arm for controlling wages inflation: migration policy. Nothing like scary Reserve Bank threats to help give politicians a little spine when they desperately need it.
Besides, by the Reserve Bank's published forecasts, it has more than 18 months before underlying inflation is in danger of breaking outside its target band of 2 to 3 per cent if it only has two 25-point rate rises in that period.
There's plenty of uncertainty still about the rest of the world, and the chance that a government that considers the lessons of history might do more on both the fiscal and labour market front to avoid the monetary stick.
It would be uncharacteristically cavalier of the Reserve Bank to lift rates next month without at least evidence that our flat retail sales are taking off or that wages are broadly breaking out. To raise when the impact of higher fuel and electricity prices are effectively doing much the same thing to discretionary spending as tighter monetary policy would verge on irresponsible.
The good news lost in all this dire talk is that our keepers of economic wisdom believe Australia is in for a period of strong growth and greater wealth, of more jobs and higher wages.
The rate rises will come soon enough as that filters through and they'll come through hard if fiscal and labour market policy is not more adaptive – but next month is too soon to "get our retaliation in first", as Willie John McBride said.
Michael Pascoe is a BusinessDay contributing editor