Australia | Jun 13 2008
By Rudi Filapek-Vandyck
Reserve Bank of Australia governor Glenn Stevens has used a speech, delivered at an American Chamber of Commerce in Australia Business Luncheon in Melbourne today, to reiterate the central bank’s bias towards the potential need for further increases in official interest rates.
While acknowledging a certain speculative element in today’s prices for oil, and other commodities, Stevens argues it is rising demand from developing countries that is currently changing the world – and pushing up global inflation.
Stevens points out that, while the dynamics in the global economy are unmistakably changing, this also applies to the Australian economy in that resources, and resources related sectors, are continuously growing in importance, to the detriment of other sectors of the economy. Stevens is of the view that, all in all, the higher pricing environment for oil and other commodities will turn out a net benefit to the Australian economy. However, his speech strongly suggests this also means that non-resource related sectors will feel more pain to balance things out and to avoid destabilising the economy over the longer term.
This is mainly because inflation will pick up and central bankers cannot allow for it to become de facto institutionalised. Says Stevens: “So inflation has picked up, and needs, over time, to be reduced. Reductions of inflation usually require a period of slower demand growth, and this episode is no different.”
Elsewhere, in a strong hint that the current commodities boom has the potential to reshape the Australian economy, Stevens talks about “sensible limits” to what can be expected from the Australian economy, explaining “Practically speaking, domestic consumption, together with housing demand, and some areas of business investment not linked to the resource sector, is being asked to make some room, for some period of time, for the rise in other forms of investment that will sustain higher incomes and living standards in the future.” However, he doesn’t think this process can be allowed to take place without close monitoring by the central bank.
Because, says Stevens, in such an inflationary scenario, “I expect that we would still find that the resources sector and the parts and regions of the economy that benefit most directly from its flow-on effects would attract additional labour and capital, and become proportionately larger in the national economy over time. Other sectors and regions would, proportionately, still diminish in size.”
The alternative would be that “The process would simply be less efficient: the price signals for resource allocation that are pretty clear at present would be more difficult to detect under conditions of higher inflation. Indeed, that is one of the problems high inflation brings. This course would also leave the rest of the economy with the legacy of embedded high inflation, commensurately higher nominal interest rates and so on. That would be harmful for living standards over time. As such, allowing it to occur would be a policy mistake.”
Elsewhere in the speech Stevens points out: “The expansionary terms of trade shock occurring now obviously would have the potential, absent some other adjustment, to be seriously destabilising [for the Australian economy].”
Conclusion: higher interest rates remain very much on the agenda. Slower domestic demand is to be expected. The rate of consumer price inflation remains the key.