For some time people have talked about a high speed rail link between Melbourne and Brisbane. Or at least Melbourne to Sydney.
A proposal was rejected by the last government on cost grounds. A new proposal is objected to on the same basis, but that's the wrong way to approach it.
Economists suggest that making a decision should be on the basis of a Cost-Benefit Analysis (CBA).
That means taking into account:
1. The direct costs of a decision e.g. The cost of building a railway and the interest on the money used to pay for it.
2. The direct revenues of a decision e.g. The value of fares collected by the railway.
3. The indirect costs of a decision e.g. The disruption caused to people who live near the railway (such as additional noise) or who have to move to allow the new railway to be built.
4. The indirect benefits of a decision e.g. The lower carbon emissions of trains over aircraft, the time saved by the passengers as a result of the new railway.
The first two are the costs and benefits considered by a firm in making a decision. The third and fourth are wider considerations which are equally important from an economists point of view.
Another point to bear in mind is that the railway will be there for a long time and so future costs and benefits, up to fifty years ahead, should be included.
The article below lists objections as 'the return is only 1%', and there 'isn't a spare $50bn lying around'. Both objections miss the point.
Firstly the return is much higher when the indirect costs and benefits are factored in over the whole time period. Secondly the $50bn is borrowed and repaid over time, it does not need to be available now. Indeed the people who will benefit form the proposed rail link will live in the future, it wouldn't be right for current taxpayers to shell out now for the railway.
Cost-benefit thinking is fundamental to economics thinking and decision making. Failure to think in those terms will lead to a lot of mistakes.
Thursday 28 November 2013
Wednesday 27 November 2013
The protection of QANTAS raises fares for passengers
Australia likes to protect its jobs, regardless of the harm it does to the bulk of the population. This has been a hard road for politicians to travel but many barriers to competition and trade have been reduced since the Hawke/Keating governments.
But the airline industry remains an area where the government allows significant barriers to entry to remain. There are two specifically:
1. QANTAS must be at least 51% Australian owned
2. International carriers need permission to fly into Australia
The result is that an oligopoly market in air travel with high barriers remains both within Australia and flying internationally. The result is that airfares are higher and service standards lower than would otherwise be the case.
The government are considering relaxing the rule on QANTAS ownership. This would allow a foreign carrier to buy the airline and operate it. They would be less sensitive to Australian jobs, such as servicing the aircraft abroad, but passengers would benefit from lower fares due to reduced costs.
However the best thing the government can do is sign up to the 'Open Skies' policy that operates in most of the developed world. Any airline can fly to and from a country as long as there are take-off and landing slots spare. This intensifies competition and lowers fares. The evidence suggests that international air fares in Australia are considerably higher than for comparable journeys.
Currently the government will not grant any more flights to foreign airlines, even though they ask on a regular basis.
Imagine if Etihad, Emirates, Thai, Singapore and all the other big carriers could fly into Melbourne six or seven times a day. Plenty of spare capacity and so cheaper seats available. Some jobs would be lost at QANTAS, but more would be created by other airlines and all travellers will benefit.
Competition works and its about time the government let it.
But the airline industry remains an area where the government allows significant barriers to entry to remain. There are two specifically:
1. QANTAS must be at least 51% Australian owned
2. International carriers need permission to fly into Australia
The result is that an oligopoly market in air travel with high barriers remains both within Australia and flying internationally. The result is that airfares are higher and service standards lower than would otherwise be the case.
The government are considering relaxing the rule on QANTAS ownership. This would allow a foreign carrier to buy the airline and operate it. They would be less sensitive to Australian jobs, such as servicing the aircraft abroad, but passengers would benefit from lower fares due to reduced costs.
However the best thing the government can do is sign up to the 'Open Skies' policy that operates in most of the developed world. Any airline can fly to and from a country as long as there are take-off and landing slots spare. This intensifies competition and lowers fares. The evidence suggests that international air fares in Australia are considerably higher than for comparable journeys.
Currently the government will not grant any more flights to foreign airlines, even though they ask on a regular basis.
Imagine if Etihad, Emirates, Thai, Singapore and all the other big carriers could fly into Melbourne six or seven times a day. Plenty of spare capacity and so cheaper seats available. Some jobs would be lost at QANTAS, but more would be created by other airlines and all travellers will benefit.
Competition works and its about time the government let it.
Tuesday 26 November 2013
Sunbeds banned in Queensland - a good move?
Merit goods are technically 'lack of information goods',
where consumers do not have all the information necessary to make a
decision on consumption, or ignore information that is relevant.
Demerit goods, such as tobacco, are similarly lack of information goods. Where they are present in the market an inefficient allocation of resources will occur. Consumers will overestimate the benefits and underestimate the costs of the good.
The result is that the quantity consumed in the market is more than the allocatively efficient level.
The diagram shows that consumers consider the good to give benefits equivalent to the demand curve D and consume quantity 0Qmkt. However the true benefits are given by the curve MSB and the efficient quantity to consume is 0Qef.
Usually an economists would say that the market price should be raised until consumers only want to buy 0Qef. But sometimes this leaves costs that are still too high.
In Australia it has long been recognised that ultraviolet radiation causes skin cancer. It appears that sunbeds cause a much greater amount of harm than natural sunlight, but consumers do not consider the full information on harmful effects and continue to use sunbeds. Therefore Australian governments are starting the process of closing solarium's.
Queensland are the latest state to ban sunbeds. The reason for a ban rather than a tax is that any consumption is harmful. As with all policy choices there are costs of acting. There is no guarantee that it will work for a while as second hand sun beds are traded and who knows if there will be a trade in illegal sunbeds from states that do not act?
Demerit goods, such as tobacco, are similarly lack of information goods. Where they are present in the market an inefficient allocation of resources will occur. Consumers will overestimate the benefits and underestimate the costs of the good.
The result is that the quantity consumed in the market is more than the allocatively efficient level.
Usually an economists would say that the market price should be raised until consumers only want to buy 0Qef. But sometimes this leaves costs that are still too high.
In Australia it has long been recognised that ultraviolet radiation causes skin cancer. It appears that sunbeds cause a much greater amount of harm than natural sunlight, but consumers do not consider the full information on harmful effects and continue to use sunbeds. Therefore Australian governments are starting the process of closing solarium's.
Queensland are the latest state to ban sunbeds. The reason for a ban rather than a tax is that any consumption is harmful. As with all policy choices there are costs of acting. There is no guarantee that it will work for a while as second hand sun beds are traded and who knows if there will be a trade in illegal sunbeds from states that do not act?
Sunday 24 November 2013
Gratton supports the need for major tax and spending reforms
The Gratton Institute, an independent organisation which publishes on economic factors in Australia, has supported the Productivity Commissions view that pension changes are necessary. But they go much further.
They identify that there is a structural budget problem that will get worse. Namely the financial commitments of the government in the future to pay pensions and benefits far outweighs the revenue they will receive in years of normal economic activity with the current tax regime. The result will be a persistent budget deficit.
The Australian tax system is a mess. Nobody really understands it and it is full of concessions to vested interests which are politically difficult to change.
None of this is new. The Henry Commission pointed this out in 2008. What the Gratton institute want is a higher pension age, restrictions on accessing superannuation funds, an extension of the GST to things like food and education and a cutting back on tax concessions.
The 'demographic time bomb' is a very real threat to the budget. The debate on how to deal with it is now getting into gear and may dominate the next Federal election.
Thursday 21 November 2013
It might not seem urgent, but it is
The Productivity Commission has proposed raising the pension age to 70. This is bound to make a lot of people unhappy, but it is a vital supply side reform that needs to be acted on now to avoid a crisis.
Actually there are two things that have to be avoided.
1. The budget deficit that will arise due to lots of non-working pensioners who don't earn to pay income taxes but do receive benefits (pensions) and demand public services, such as Medicare.
2. The reduction in the relative, and probably absolute, size of the working population. Those working will have to pay the taxes and produce the goods and services that the retired population needs. It would create a huge burden on them.
So the Productivity Commission's plan helps with both. The government does not have to support people for three extra years, probably saving about 10% on the pensions bill. The budget will be healthier as a result, with government spending being lower than it otherwise would be.
Further the size of the working population will be larger as those aged 67 to 70 are encouraged to stay in the working population. Not only does this add revenue from income taxes to the government, it also boosts Aggregate Supply. Any rise in the labour force shifts the AS curve to the right. The result is higher output and lower inflationary pressure.
The third effect worth noting is in income distribution. Here we must consider inter-generational equality. The young don't have such a heavy burden to support the old. While old age pensions have allowed a much kinder and fairer society in the past the ageing population will cause an increasingly unfair burden in the future.
Why is it urgent that action is taken now? Such a measure cannot be introduced overnight. A 66 year old cannot be told in 2014 that he/she cannot retire until they are 70. They need to plan for such a change. So if this measure is adopted the retirement age will probably rise a year at a time over a decade.
Actually there are two things that have to be avoided.
1. The budget deficit that will arise due to lots of non-working pensioners who don't earn to pay income taxes but do receive benefits (pensions) and demand public services, such as Medicare.
2. The reduction in the relative, and probably absolute, size of the working population. Those working will have to pay the taxes and produce the goods and services that the retired population needs. It would create a huge burden on them.
So the Productivity Commission's plan helps with both. The government does not have to support people for three extra years, probably saving about 10% on the pensions bill. The budget will be healthier as a result, with government spending being lower than it otherwise would be.
Further the size of the working population will be larger as those aged 67 to 70 are encouraged to stay in the working population. Not only does this add revenue from income taxes to the government, it also boosts Aggregate Supply. Any rise in the labour force shifts the AS curve to the right. The result is higher output and lower inflationary pressure.
The third effect worth noting is in income distribution. Here we must consider inter-generational equality. The young don't have such a heavy burden to support the old. While old age pensions have allowed a much kinder and fairer society in the past the ageing population will cause an increasingly unfair burden in the future.
Why is it urgent that action is taken now? Such a measure cannot be introduced overnight. A 66 year old cannot be told in 2014 that he/she cannot retire until they are 70. They need to plan for such a change. So if this measure is adopted the retirement age will probably rise a year at a time over a decade.
The 2012 data clearly shows how the pension crisis will hit Australia in the next 20 years
Monday 18 November 2013
Australia's climate change shame
The UN Climate Change negotiations are currently taking place in Poland. Australia has declined to send any Ministers, an unprecedented move that has drawn condemnation from many quarters.
On Monday the latest Climate Change Performance Index was published and Australia comes out badly.
You would be forgiven for thinking that under Rudd/Gillard Australia was really out there pushing the boundaries on climate change, and that the Carbon Tax was a major policy initiative that left other countries lagging behind. In truth Australia was 51st of 61 countries on the league table of countries doing most to alleviate climate change.
With the repeal of the Carbon Tax by the idiot Abbott simply to score a political point Australia is now seen as a force that is "anti-climate" and has dropped to 58 out of 61*.
The Economics of climate change is clear and without reservation says that a price must be placed on carbon. My own country lags only behind Denmark on the league table and the measures taken there have widespread and bipartisan support. It's time Australia stopped being so selfish.
On Monday the latest Climate Change Performance Index was published and Australia comes out badly.
You would be forgiven for thinking that under Rudd/Gillard Australia was really out there pushing the boundaries on climate change, and that the Carbon Tax was a major policy initiative that left other countries lagging behind. In truth Australia was 51st of 61 countries on the league table of countries doing most to alleviate climate change.
With the repeal of the Carbon Tax by the idiot Abbott simply to score a political point Australia is now seen as a force that is "anti-climate" and has dropped to 58 out of 61*.
The Economics of climate change is clear and without reservation says that a price must be placed on carbon. My own country lags only behind Denmark on the league table and the measures taken there have widespread and bipartisan support. It's time Australia stopped being so selfish.
*The countries below Australia are Iran, Kazakhstan and Saudi Arabia
Friday 15 November 2013
The Great Australian Complacency - the real issue
Ross Garnaut is probably the best known Australian economist working in Australia (Geoff Harcourt is the best Australian economist, but is at Cambridge). Garnaut has the ability to pinpoint the real issues facing Australia, as he did with climate change.
He has now entered the debate about the great danger that faces the Australian economy, namely it is high wage and low productivity and there has to be a unified and bipartisan approach to solving this.
The article below was motivated by Maurice Newman's contention that its all the fault of a high minimum wage in Australia. Newman is an adviser to the idiot Abbott and a climate change denier and represents the sort of partisan politics that Garnaut is arguing has got to stop.
Lets deal with productivity first. Productivity is a measure of efficiency, how much of an input has to be used to produce a given amount of output. The higher the level of productivity the higher the level of wages that can be afforded. Productivity is raised by investment in capital and people and using resources to their maximum potential.
Australian's are complacent about the challenges of the future according to Garnaut. They want higher wages but are not prepared to make the changes necessary to raise productivity. He blames the pursuit of self interest by unions and employers and the disfunctional process of government.
Newman on the other hand wants the minimum wage to be lowered to make it cheaper for firms to employ people. He also wants lower taxes on firms. Both raise profits.
The contrast between the approach of the academic, Garnaut, and the vested interest of business, Newman, is something those studying Economics must be able to distinguish between.
The data in the article on Newman shows that Australia does have a high minimum wage. It's Australian to aim for greater equality and such a choice is quite reasonable by a society. But that does not mean people can simply sit back and enjoy the them, they have to justify the high wages with high productivity.
Just to be clear this is not just the fault of business as represented by Newman. The 'new Founders building' would have been ready for the start of Term 4 in Europe, but union intransigence on work practices means it will be a close run thing for Term 1.
He has now entered the debate about the great danger that faces the Australian economy, namely it is high wage and low productivity and there has to be a unified and bipartisan approach to solving this.
The article below was motivated by Maurice Newman's contention that its all the fault of a high minimum wage in Australia. Newman is an adviser to the idiot Abbott and a climate change denier and represents the sort of partisan politics that Garnaut is arguing has got to stop.
Lets deal with productivity first. Productivity is a measure of efficiency, how much of an input has to be used to produce a given amount of output. The higher the level of productivity the higher the level of wages that can be afforded. Productivity is raised by investment in capital and people and using resources to their maximum potential.
Australian's are complacent about the challenges of the future according to Garnaut. They want higher wages but are not prepared to make the changes necessary to raise productivity. He blames the pursuit of self interest by unions and employers and the disfunctional process of government.
Newman on the other hand wants the minimum wage to be lowered to make it cheaper for firms to employ people. He also wants lower taxes on firms. Both raise profits.
The contrast between the approach of the academic, Garnaut, and the vested interest of business, Newman, is something those studying Economics must be able to distinguish between.
The data in the article on Newman shows that Australia does have a high minimum wage. It's Australian to aim for greater equality and such a choice is quite reasonable by a society. But that does not mean people can simply sit back and enjoy the them, they have to justify the high wages with high productivity.
Just to be clear this is not just the fault of business as represented by Newman. The 'new Founders building' would have been ready for the start of Term 4 in Europe, but union intransigence on work practices means it will be a close run thing for Term 1.
Saturday 9 November 2013
Rare sense from the Coalition on borrowing
The Coalition made a great show of claiming the budget was in crisis for the last five years. While this was simply (bad) politics it has clouded the issue to a dangerous degree as people believed the propaganda.
Now the Government are considering the very sensible move of distinguishing between borrowing to fund investment and borrowing to pay everyday bills. This is quite normal in other countries.
The argument works like this. If you borrow money and buy ice cream then you are simply funding consumption today and will have to pay back later. But you have nothing to show for your borrowing except a bigger waistline.
If you borrow to buy a business then you are borrowing to fund future consumption. While you have to pay back the loan you have bought an income stream to do that and make a profit.
For the government it is a similar story. If they borrow to pay the wages of government employees and to subsidise prescription drugs then they are buying ice cream. It does somebody some good now but you have to pay it back later which means higher taxes.
When the government funds infrastructure spending through borrowing they are adding to the capital stock of the nation. It allows businesses to operate more efficiently and competitively. The government has given the economy the chance to grow more quickly than it otherwise would. The higher taxes paid by individuals and firms in the future pays back the borrowing.
The NBN, new railways and ports are all good examples of infrastructure spending, while higher spending on schools and universities adds to human capital. They all add to Australia's ability to produce goods and services at competitive prices.
From this it follows that borrowing for infrastructure is good, providing the benefits outweigh the costs. In a modern economy the government should always be in debt to fund infrastructure projects as part of a long term supply side policy.
Therefore the stupid contest between political parties to return to an overall surplus faster than the other is fundamentally flawed. The change to distinguishing between a deficit to fund current spending and capital spending needs to be done and Joe Hockey will have to explain this to the idiot Abbot in words of a few syllables.
Now the Government are considering the very sensible move of distinguishing between borrowing to fund investment and borrowing to pay everyday bills. This is quite normal in other countries.
The argument works like this. If you borrow money and buy ice cream then you are simply funding consumption today and will have to pay back later. But you have nothing to show for your borrowing except a bigger waistline.
If you borrow to buy a business then you are borrowing to fund future consumption. While you have to pay back the loan you have bought an income stream to do that and make a profit.
For the government it is a similar story. If they borrow to pay the wages of government employees and to subsidise prescription drugs then they are buying ice cream. It does somebody some good now but you have to pay it back later which means higher taxes.
When the government funds infrastructure spending through borrowing they are adding to the capital stock of the nation. It allows businesses to operate more efficiently and competitively. The government has given the economy the chance to grow more quickly than it otherwise would. The higher taxes paid by individuals and firms in the future pays back the borrowing.
The NBN, new railways and ports are all good examples of infrastructure spending, while higher spending on schools and universities adds to human capital. They all add to Australia's ability to produce goods and services at competitive prices.
From this it follows that borrowing for infrastructure is good, providing the benefits outweigh the costs. In a modern economy the government should always be in debt to fund infrastructure projects as part of a long term supply side policy.
Therefore the stupid contest between political parties to return to an overall surplus faster than the other is fundamentally flawed. The change to distinguishing between a deficit to fund current spending and capital spending needs to be done and Joe Hockey will have to explain this to the idiot Abbot in words of a few syllables.
Thursday 7 November 2013
The dangers of not competing
Qantas have announced they will stop maintaining aircraft at Avalon. Despite the protests of the engineers they have themselves to blame to some degree.
The decision will mean that part of the Qantas fleet will be maintained abroad where it is much cheaper to do so. While this is unfortunate, especially for Geelong who might welcome Australia's first nuclear power plant right now, it is an illustration of the benefits of trade.
As Qantas will be able to save money on maintenance by this move they will be able to charge lower fares. Those lower fares will benefit Qantas consumers directly and other passengers as it adds to competition in the market.
There is no point complaining about lower wages abroad or lower quality (first may be true but the second isn't). The fact is that countries should specialise in what they are comparatively best at and import the rest. In the long run nobody wins by subsidising uneconomic industries, the taxpayers and consumers pay more for a brief period of higher wages and employment for the inefficient.
The actual answer is to invest in human capital via education and training to make Australia competitive in the high tech, knowledge based industries that will allow Australians to maintain their standard of living. The alternative is to drop living standards to those of the bulk of the Asian Pacific region. There will be few takers for that.
The decision will mean that part of the Qantas fleet will be maintained abroad where it is much cheaper to do so. While this is unfortunate, especially for Geelong who might welcome Australia's first nuclear power plant right now, it is an illustration of the benefits of trade.
As Qantas will be able to save money on maintenance by this move they will be able to charge lower fares. Those lower fares will benefit Qantas consumers directly and other passengers as it adds to competition in the market.
There is no point complaining about lower wages abroad or lower quality (first may be true but the second isn't). The fact is that countries should specialise in what they are comparatively best at and import the rest. In the long run nobody wins by subsidising uneconomic industries, the taxpayers and consumers pay more for a brief period of higher wages and employment for the inefficient.
The actual answer is to invest in human capital via education and training to make Australia competitive in the high tech, knowledge based industries that will allow Australians to maintain their standard of living. The alternative is to drop living standards to those of the bulk of the Asian Pacific region. There will be few takers for that.
Wednesday 6 November 2013
Unemployment at 5.7%
Australia's latest unemployment figures released today show 5.7% of the workforce as unemployed. Depending on how you look at it that's up 0.1% or steady because last months figure was revised upwards to 5.7%.
The real worry is that jobs are not being created very quickly. There was a net rise of about 1000 jobs if you accept part-time jobs, which rose, to be as useful as full time jobs, which fell. Of course nobody does see them as equivalent so there was really a net fall in employment.
The participation rate also fell to 64.8%. While this is the lowest level since 2006 a quick look at the chart in the ABC News report shows that while there is a slight trend downwards this is not severe and may well indicate the relatively high level of unemployment and scarcity of full time jobs has put some job seekers off for now.
Australia considers 5% unemployment as 'full employment'. That's quite a high level to accept as full employment, but few OECD countries are achieving 5.7% let alone 5%. Use the link to the map below to see where Australia ranks (hover over a country to get the data).
Australia should be concerned about unemployment. Those unemployed suffer a lower standard of living and impose costs upon the economy and taxpayers. Rising unemployment also indicates slow growth and possibly skill shortages among the available workforce. If the upward trend in unemployment, which started in early 2012, continues it will require further policy measures to boost growth.
The real worry is that jobs are not being created very quickly. There was a net rise of about 1000 jobs if you accept part-time jobs, which rose, to be as useful as full time jobs, which fell. Of course nobody does see them as equivalent so there was really a net fall in employment.
The participation rate also fell to 64.8%. While this is the lowest level since 2006 a quick look at the chart in the ABC News report shows that while there is a slight trend downwards this is not severe and may well indicate the relatively high level of unemployment and scarcity of full time jobs has put some job seekers off for now.
Australia considers 5% unemployment as 'full employment'. That's quite a high level to accept as full employment, but few OECD countries are achieving 5.7% let alone 5%. Use the link to the map below to see where Australia ranks (hover over a country to get the data).
Australia should be concerned about unemployment. Those unemployed suffer a lower standard of living and impose costs upon the economy and taxpayers. Rising unemployment also indicates slow growth and possibly skill shortages among the available workforce. If the upward trend in unemployment, which started in early 2012, continues it will require further policy measures to boost growth.
Tuesday 5 November 2013
Coalition sets confused message on budget, but confirms CEDA's concern
Today Joe Hockey, The Federal Treasurer, dropped tax increases which will cost the government $3.1billion. This is despite the fact that there was a 'budget crisis' according to the Coalition during the election campaign.
The taxes dropped are a mixture of measures, but on the whole the Treasurer has pandered to vested interest. It is perhaps no coincidence that today CEDA (Committee for Economics Development of Australia) issued a report calling for a reform of the tax system, measures to improve productivity and an end to subsidies that maintain poorly performing industries that can't compete without state help.
Hockey has stated he will repeal the Mining Resources Rent Tax, largely to placate the powerful mining lobby. Taxes on Economic Rent are one of the few taxes that have no impact on output and are seen as unambiguously good and fair. He has also decided not to introduce changes to Fringe Benefit Tax which helps the car industry by legalising tax evasion.
There are two key issues to consider:
1. Is there really a budget emergency?
2. Is there any political will to simplify and improve Australia's tax system?
1. The obvious answer is no. Australia has a very small deficit on its budget and very low National Debt. The current deficit could be sustained indefinitely without any trouble whatsoever.
2. This too is a no. The Henry Commission suggested sensible reforms to the tax system which were basically ignored. The problem is that Australian politicians are weak and more concerned with keeping power than dealing with real problems. Every tax concession, however unjustifiable, loses somebody's vote and rarely gains as many.
It is not possible to do justice to the issued raised in a single post. However there are many questions to take up over the coming year before the next VCE exam.
The taxes dropped are a mixture of measures, but on the whole the Treasurer has pandered to vested interest. It is perhaps no coincidence that today CEDA (Committee for Economics Development of Australia) issued a report calling for a reform of the tax system, measures to improve productivity and an end to subsidies that maintain poorly performing industries that can't compete without state help.
Hockey has stated he will repeal the Mining Resources Rent Tax, largely to placate the powerful mining lobby. Taxes on Economic Rent are one of the few taxes that have no impact on output and are seen as unambiguously good and fair. He has also decided not to introduce changes to Fringe Benefit Tax which helps the car industry by legalising tax evasion.
There are two key issues to consider:
1. Is there really a budget emergency?
2. Is there any political will to simplify and improve Australia's tax system?
1. The obvious answer is no. Australia has a very small deficit on its budget and very low National Debt. The current deficit could be sustained indefinitely without any trouble whatsoever.
2. This too is a no. The Henry Commission suggested sensible reforms to the tax system which were basically ignored. The problem is that Australian politicians are weak and more concerned with keeping power than dealing with real problems. Every tax concession, however unjustifiable, loses somebody's vote and rarely gains as many.
It is not possible to do justice to the issued raised in a single post. However there are many questions to take up over the coming year before the next VCE exam.
Australia's Debt is low by international standards. Source: ABC
Monday 4 November 2013
Cash rate on hold, but a war of words on the exchange rate
The RBA kept the cash rate on hold today. This was expected, despite the latest inflation rate figures being slightly higher than expected.
The RBA have tended to over react to inflation figures in the last eighteen months, which is odd because they know interest rates take up to two years to affect the headline inflation rate. On this occasion other considerations may have outweighed inflation concerns.
The RBA are worried about the future growth of the economy. The mining sector is investing less and the fall in commodity prices means that export values are falling. Together that means lower Aggregate Demand and so lower inflationary pressure in the medium term.
The non-mining sector has to provide the growth which is necessary to maintain employment. A key issue for the non-mining economy is the exchange rate. The resources boom pushed the exchange rate up, made imports cheaper and exports more expensive for foreigners.
Now the exchange rate needs to fall to help the non-mining sector grow. Imports will be less competitive and exports cheaper allowing a boost to Aggregate Demand (assuming the Marshall-Lerner conditions hold).
The RBA could lower interest rates to help make the $Aus less attractive to hold (as relative exchange rates abroad stay the same). Instead they have opted to 'talk down' the $Aus in order to achieve the lower exchange rate. They clearly indicate that a lower interest rate will be set next year, which should lead to a fall in the exchange rate. But now the $Aus should fall on the expectation of this change. Why hold Australian dollars until they fall in value when you can sell now?
So the RBA can eat their cake and have it. They maintain anti-inflationary pressure by not lowering interest rates and get a a lower exchange rate to help boost growth. Let's hope it works.
The RBA have tended to over react to inflation figures in the last eighteen months, which is odd because they know interest rates take up to two years to affect the headline inflation rate. On this occasion other considerations may have outweighed inflation concerns.
The RBA are worried about the future growth of the economy. The mining sector is investing less and the fall in commodity prices means that export values are falling. Together that means lower Aggregate Demand and so lower inflationary pressure in the medium term.
The non-mining sector has to provide the growth which is necessary to maintain employment. A key issue for the non-mining economy is the exchange rate. The resources boom pushed the exchange rate up, made imports cheaper and exports more expensive for foreigners.
Now the exchange rate needs to fall to help the non-mining sector grow. Imports will be less competitive and exports cheaper allowing a boost to Aggregate Demand (assuming the Marshall-Lerner conditions hold).
The RBA could lower interest rates to help make the $Aus less attractive to hold (as relative exchange rates abroad stay the same). Instead they have opted to 'talk down' the $Aus in order to achieve the lower exchange rate. They clearly indicate that a lower interest rate will be set next year, which should lead to a fall in the exchange rate. But now the $Aus should fall on the expectation of this change. Why hold Australian dollars until they fall in value when you can sell now?
So the RBA can eat their cake and have it. They maintain anti-inflationary pressure by not lowering interest rates and get a a lower exchange rate to help boost growth. Let's hope it works.
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