I’m sure that I’m not the only person confused with the economic decision from the Reserve Bank of Australia (RBA) to apply yet another rate increase this week. Twelve consecutive rate rises and three in the last six months – levelled at controlling inflation. RBA had concerns and believed that a 50 basis point increase in February would be severe, so it opted for a 25 basis point increase which it then mirrored in March (work that logic out). Yesterday, National Australia Bank (NAB) raised its variable home loan rate by 0.29 per cent (RBA on Tuesday applied a 0.25 per cent increase to 7.25 per cent) its home loan rate is now 9.27 per cent effective today. NAB executive director and CEO, Ahmed Fahour said “Escalating wholesale funding costs have been impacting NAB since August 2007. During February this year, the cost of both short and long term wholesale funding rose to their highest levels in a decade.” Makes one – ponder why, the RBA keep focusing on inflation. Mr Fahour went on to say “Unfortunately this means the increase in the RBA’s cash rate by 0.25 per cent does not reflect the true cost of funding a home loan. Even with the additional 0.04 per cent change on variable rate products, NAB is continuing to absorb a significant portion of the increased wholesale funding costs.”

So the cost of money keeps increasing yet, the RBA wants to reduce spending?

So the RBA wants to curb domestic spending currently running at 4 per cent back, to 2.75 per cent as it believe this needs to be contained within a 2 to 3 per cent RBA comfort zone. I wonder which year this formula was applied ? What was a litre of petrol (maybe a gallon)? This week oil companies suggested $3.00 a litre in a few years time. What was the residential vacancy rate? Over the last five years it has reduced by 75 per cent hence the rental crisis where rents keep climbing and climbing. Throw in a few droughts where the cost of food has skyrocketed and the RBA wants to rein in spending. What part of this rationale am I missing, given that these are survival costs where domestic spending keeps going up!

On Wednesday March 5, UBS senior economist Adam Carr wrote in www.crikey.com.au “If inflation’s the question, rate rises are not the answer”. Mr Carr wrote” This is the 12th rate hike this cycle and the highest cash rate since mid-1996. Yet such an outcome appears odd given the state and fragility of the global economy and, in particular, given that the US is in a recession. The additional problem is that Australia is currently facing a housing affordability crisis and major hurdles in terms of residential construction. A rising cash rate here will only exacerbate these issues. The problem, in the RBA’s view, is that the Australian economy is just too hot and consequently we’re now running up against capacity constraints. In turn, the RBA suggests that the combination of strong domestic demand and capacity constraints is the engine driving the inflation problem that Australia now faces. But herein lays the danger. Domestic demand, and in particular consumer demand, is not the driving force behind the inflation problem at present. The facts are pretty clear. Take the December quarter CPI showing headline inflation rising by 0.9%. Of this, 0.7%pts (or 77% of the increase) was due to four components: fuel, housing, rents, ‘alcohol and tobacco’ and financial services. Over the last two years food alone has accounted for about 40% of the increase in inflation.

Price increases in these components aren’t being driven by strong domestic demand. They are being driven by factors largely outside the control of monetary policy – global demand/supply issues, the drought, the liquidity crisis, tax and excise and a shortage of housing. With a number of these factors set to unwind over the year given the global economic slowdown and recent rainfall, there is a serious risk that the RBA will lean too hard against the economy as it waits for evidence that domestic demand is slowing. This at a time that the US economy is in recession. The risks to Australia’s prosperity are consequently material.

Yet the risks needn’t be material. There is an alternative. By focussing policy on actual drivers of inflation, better policy outcomes – ones that don’t involve inducing slower growth and higher unemployment – could be achieved. That’s not to say that government policy can target global oil or food prices. No, but they can increase immigration and ease the skills shortage, they can restrict the extent to which tax and excise exacerbate price rises. Governments can look at tax and excise issues that are driving inflation higher such as the excise on alcohol and tobacco, local government property taxes and charges (which have risen at an average of 5 ½ % over the last few years) and stamp duty. Moreover, adopting policies which ease the rental squeeze and add to the stock of affordable housing would also do much to cap inflation – which without crunching growth and putting people out of work.

It’s important to note that the Bank’s target is to keep inflation within the 2-3% band over the course of the business cycle. Not to mention let inflation rise above 3%. In that regard and given the unique circumstances the global economy is in – it may be wise to allow a little more leeway in that regard. There is little evidence to suggest that an inflation rate of 4% is harmful.”

Brings one back to the GST rort where taxes have not been reduced since its introduction – on the contrary they have actually been increased by governments. The Commonwealth Grants Commission has released its findings on how GST funding will be distributed among the states and territories for 2008-09. For the first time since GST was introduced Western Australia has beaten NSW to become the state with the strongest capacity to raise revenue. This comes as little surprise given a recent survey by Fairfax/Nielsen which found one in five NSW residents are contemplating leaving the state citing the high cost of living and lack of employment opportunities. Why am I not surprised ? The total GST, donations to state governments is $54.2 billion. NSW – reaped the highest donation of $16.100 billion.

Next week (on things that keep going up) we will focus on the Dyson Austen top 10 prestige residential survey. Economists collect facts, then draw their own “confusions”. I believe Adam Carr is 100% correct – governments have taxed constituents and made a significant contribution to the current demise. Sending families bankrupt is NOT the answer. Cheers ^__^

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