Headline inflation down, underlying inflation up

Yesterday the June quarter inflation figures showed that the CPI in Australia was running at an annual rate of 1%. That is well below the RBA target of 2- 3% on average over the business cycle. There is a wide expectation of further interest rate cuts, if not at the August meeting of the RBA certainly by the end of the year.

The figures, which are summarized below by the ABS, do disguise a rise in underlying inflation (that is with volatile items removed) has risen to 1.5% (from 1.4%). Underlying inflation does give a better picture of what is happening in the economy, but is still very low. Indeed these are the lowest recorded inflation figures for 17 years.

The question of the next move in monetary policy is dominating the press. Many argue that the RBA must lower interest rates to boost Aggregate Demand to avoid deflation and possible recession. However others, such as former RBA Board member Professor Warwick McKibbin, argues that moving rates to near zero (or zero in Japan) did nothing to help other economies as changes in rates at such low level has no significant effect on saving and investment incentives. 

The danger of very low rates lies in reducing retirement incomes and further distorting the housing market.

The ABC cover the story here

The article is of direct relevance to VCE students who must be aware of Australian inflation movements, the influences on the figures and the monetary policy response. IB students will find this useful as an example of inflationary pressures and policy response, they should also look at the use of inflation targets and pros and cons of monetary policy in a situation of low inflation/rates where 'conventional monetary policy' is ineffective.