Reload About It

Australia’s Monetary Policy: Right or Wrong?

The International Monetary Fund (IMF) came out this week and claimed that Australia (as well as a number of other Western countries including New Zealand, Canada & the UK) has been getting it wrong when it comes to our inflation targeting approach to monetary policy.

In economies that use an inflation-targeting approach to monetary policy, central banks will adjust the official cash rate in order to help keep inflation within a “normal” range. The argument from the IMF is that in order to give more policy “room” during downturns, we need to set a higher inflation target.

In Australia, the Reserve Bank uses an inflationary range of 2-3% as its guide when making monetary policy decisions. The RBA will thus use interest rates in order to slow an overheating economy (by raising the cash rate) or to pick up a slowing economy (by cutting rates).

However, Australia has one of the more liberal approaches in the world already, with most other countries targeting an inflationary range of between 1-2%.

Given the fact that Australia rode out the global recession far better than most others, one might argue that the IMF is on to something. Interestingly, the IMF also claimed that cash handouts, like those given out by the Rudd Government, should also be one of the first actions made in a downturning economy.

So whilst right now it looks like Australia has handled the downturn far better than most, the question will be how do we handle the inevitable upswing?

Two to three years ago, the story was completely different. Australia’s economy was still humming along nicely, and inflation was well above the targeted range.

As a result, the RBA continued to lift interest rates in an attempt to control it. However, around this time, there were strong calls that Australia’s economic inflation was being driven up by international pressures, like the price of oil, not domestic ones.

This lead to calls for the RBA to ignore what was deemed “imported inflation,” as domestic monetary policy decisions were unlikely to affect global sentiment.

Despite this, interest rates continued to be lifted, and when the world went into meltdown the RBA had no choice but to start slashing at the official cash rate, a move that most likely did more harm than good.

Having said all this, it does appear that the RBA has learnt some lessons from recent times, as they seem less inclined to tamper with the currency’s value (as this puts upward pressure on inflation) and have also assessed how the big banks respond to cash rate increases.

Food for thought…

2010: The Year For Importers

While the world recovers from the global recession, Australia is taking it pretty easy.

Job losses were below anticipated figures, GDP growth rates exceeded expectations, and interest rates didn’t reach the “free money” levels of some other economies.

As a result of this, and some economic resilience by China, the Australian dollar is holding at above US 90 cents, and I tend to believe that this will continue to rise and hit US $1.10 by Christmas.

Many would consider this prediction impossible, given that since the dollar was floated in 1983 we are yet to hit parity with the US, but there’s a few more ‘ducks in a row’ this time around.

For one, and possibly the biggest factor, was the comment made by RBA Governor Glenn Stevens late last year that the RBA would not be interfering with the currency’s value during this ascent.

Normally, the RBA will trade in foreign exchange reserves to dampen the dollar’s value. This keeps our export prices from becoming too expensive for the rest of the world.

The downside to this is that the practice of dampening the currency causes inflation, which in turn puts upward pressure on interest rates, which is probably one of the reasons why the RBA has chosen not to interfere this time. That, and the fact that we now have significant Government debt, adds further weight to the argument for a higher Aussie dollar.

So whilst the higher dollar puts exporters under pressure, it does open the door for local retailers of imported goods to make their mark. Australian sellers of foreign-produced goods are facing potentially one of the most lucrative periods of the last 20 years.

This makes 2010 a great year to be an importer.