Money
Issue No. 41 - June/July 2008
Rate hikes cause inflation backfire
by Mr Marcus Campbell
Are interest rate hikes pushing up inflation?
Inflationary pressures continue to build in the domestic economy, with higher energy (oil) and food costs pressing the RBA’s inflation targets.
With housing affordability at record lows, while rents continue to rise, mounting inflation presents a possible scenario of interest rates staying at current levels into the first half of 2009.
Recently our Goldman Sachs JBWere economists reviewed the subject of interest rates, the components
of inflation and the effects they have more broadly on the economy.
If there has been one overriding principle throughout Australia’s 15-year inflation-targeting tradition, it would be the following: any measure from which monetary policy is decided should be impervious to interest rate hikes. Since 1998, this has been the case.
In 1998, the mortgage interest rate charge was specifically excluded from the official measure of the Treasury’s underlying inflation measure. Continuing to this day, all of the analytical measures of inflation that the RBA publishes on its website specifically exclude
this component.
The reason for this exclusion is well justified. If by hiking rates to control inflation a central bank is actually directly boosting inflation, this would not only be counterproductive but would introduce instability into the economy.
Inevitably, the central bank would inadvertently ‘over-tighten’ as inflation moved higher and ease too much as inflation retreated. This sort of behaviour would increase the volatility of the economic cycle as well as increase the chance of an imbalance building in
the economy.
The Deposit & Loan complication
However, since September 2005, Australia’s measure of inflation has had an interest rate element added which - in the opinion of our analysts - has had a negative impact.
Unfortunately, the introduction of the 15th CPI series (financial s...
