Reserve Bank of Australia (RBA) Update

Macquarie Research Equities (An Australian market analyst) highlighted a number of key points about RBA’s policy framework that formed the basis of growing criticism over the RBA’s stance.

Reserve Bank of Australia (RBA) – Playing the Inflation Game

Current Australian monetary policy tactics have come under intense pressure recently and Macquarie Research Equities (MRE) deliberates their discourse on the fundamental tactics of the Reserve Bank of Australia (RBA). MRE highlight a number of key points that form the basis of growing criticism over the RBA’s stance. The arguments are based on the RBA’s policy framework against current market conditions and their effectiveness in communicating such strategies to the general market.

Following are three of the contentious issues discussed by MRE:

1. The RBA is perhaps powerless to combat cost-push inflation. One argument supporting this issue is that current inflationary pressure is being driven largely by supply side economics as opposed to demand fundamentals. For example, rising food, petrol, electricity or housing construction prices do not reflect an increase in consumer demand. One possible concern MRE mentions is that if inflation is being driven by rising global commodity prices then the RBA is powerless to combat it and shouldn’t attempt to curtail the subsequent impacts by lifting interest rates - certainly a contentious issue.

2. Should the RBA attempt to combat cost-push inflation?This point is more about whether the RBA should maintain their 2 – 3% target band when market conditions are “far from normal”. Should they, therefore, incorporate different dynamics suited perhaps to extreme market conditions as we have seen over the last 8 months. This was seemingly a successful approach taken by the German Bundesbank in the 1970’s when global inflation accelerated on the back of surging Oil prices.

3. RBA communication and cost-push inflation. The conundrum the RBA faces with cost-push inflation is that this particular measure is coupled with falling growth. Thus the RBA faces attacks from those people wanting to curb inflation and others who feel they are not doing enough to stimulate growth.

Whilst the complexities of the cost-push inflation argument go well beyond the issues highlighted in this article, it is quite apparent that the RBA faces a difficult task in managing the monetary stance of the Australian economy. Coupled with increasing costs and easing global growth the RBA must be somewhat bipartisan in their policy. Yesterday we saw the RBA again leaves interest rates unchanged with some analysts forecasting no change for the remainder of the year. The inflation problem is finally not a short term issue as the RBA has forecast the rate to stay above 3% at least until 2010.