Posted: July 26, 2006

Now the lunacy begins!

The ABS today released the latest CPI figures which shows that Australia's annual inflation rate is running at 4 per cent. Not surprisingly natural calamity (bananas) and world-wide petroleum cost rises are to blame. Price rises are also coming from housing purchases, rent, health costs, tobacoo and furniture.

The relevance of these trends is that the annual rate is now 1 per cent above the RBA's target upper bound. The problem is that the bank will now in Pavlovian fashion put interest rates up again ... and so the lunacy begins.

Australia has not fully recovered from the last major recession. We still have 1.8 million workers without enough work, with probably over a million without any work.

Australian households are holding record levels of debt and many are teetering on the edge of bankruptcy. For each 250k held in mortgage a 25 basis points (1/4 per cent of 1 per cent) rise adds about $40 per month to the household expenses.

The last two times petrol prices have risen sharply like this the world economy has entered a severe recession. Maintaining liquidity in the non-government sector is vital in times of cost squeeze. Putting interest rates up not only directly impacts on the costs of households and businesses but also exacerbates the liquidity impacts of the fiscal drag that coming from the Federal budget surplus. Both policy settings will further damage employment growth and increase unemployment.

This is even more stark when you consider the thrust of Federal policy with respect to unemployment are twin-evils of Welfare-to-Work and Work Choices, neither will generate a single job but will rather just punish the victims of the erroneous policy choices.

The RBA should not increase interest rates and use the unemployed as a price anchor. Rather it should manage the labour supply that the private sector currently does not wish to employ. This management should take the form of an employment buffer - the Job Guarantee - which in itself constitutes a powerful price anchor.

Blog entry posted by bill