Thursday 30th November 2006
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But there's a good argument that we've got a bit complacent about the state of inflation. Although, like everywhere else, our 'headline' inflation rate has been affected by world oil prices, it's rather worrying that the headline rate here, at 4%, is higher than practically everywhere else we like to compare ourselves with (and higher than many of the developing economies' rates). And it's rather worrying, too, that one of the key measures of the everyday prices we pay for many domestic goods and services (called 'non tradables' inflation in the jargon) has been running at over 4% for two years now.
The conventional response is to blame the Reserve Bank. And if it was showing a systematic pattern of calling things wrong, that would be entirely appropriate. But that's not really borne out. With hindsight, it might have done things a bit differently (notably a precautionary SARS-and-sharemarket-meltdown easing in 2003 that wasn't needed and that helped get the bonfire going) but it hasn't been unprofessional at its job. It hasn't helped that monetary policy has lost some of its bite (because so many people have been insulated, at least for a while, by having fixed rate mortgages), nor that fiscal policy has turned to strongly boosting the economy - the exact opposite of what the inflation cycle requires. Overall, you'd have to give the bank some credit for battling along as well as these various factors have let it.
I'm inclined to look at more structural issues. Inflation rises when the economy is close to or above its 'potential' output - think of it as everyone at full stretch. When there's a 'positive output gap', we're temporarily above our usual full-stretch capability (for example, by working unusually large amounts of overtime). Resources are scarce and prices start rising faster. All very straightforward.
The best the Reserve Bank can do is slow the economy back below the full-stretch level and create a 'negative output gap', where resources are freed up and people are less prepared to pay fancier prices for them. It can't do much at all about the full-stretch potential output level itself.
But other policies can. Potential output increases (and the inflationary roadblock, therefore, recedes) the more people we've got in the labour force, the more investment we make for them to work with, and the smarter we all are at making things. And, frankly, we're falling down on the first two of those (the third, which is our productivity, has actually been coming along quite nicely).
Looking at the size of the labour force, the only level we've got to pull in the short to medium term is the level of immigration. And it's simply been inadequate in the past few years. We attracted a net 12,500 people in the year to August, when we should be aiming for two to three times that. We gained 36,200 in the year to August 2002 and 41,150 in the following year, though helped by people staying at home post 9/11 and post Bali.
Successive governments' spending on infrastructural investment has also been too weak. As noted in this column previously, it's a major exercise even to calculate what public capital spending has been, since Budgets focus overwhelmingly on other things - especially current spending on social services and transfer payments, and the tax take. When you do the exercise, you find that the infrastructure spend is a very small proportion of the overall total, and not keeping pace with the demands on it. And if governments aren't prepared to make the spend themselves, the least they could do is get out of the way and let others do it: if even Australia has had the wit to promote private sector roads, to everyone's benefit, so should we.
We're never going to abolish cyclical fluctuations in inflation: we'll always have issues when we approach our potential output barrier. But we could be doing a lot more to move that barrier further away.
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