Inflation: who's to blame?

WITH THE RUDD GOVERNMENT'S first Budget almost upon us, how will it approach the inflation situation now confronting it?

Much time since Labor's victory last November has been devoted to charges and counter-charges about the economic inheritance bequeathed to it by the Howard government. On the economy overall there is really not much room for argument. The new government clearly inherited an economy surging ahead on almost all fronts. Non-farm gross domestic product grew by 4.0 per cent during calendar 2007, and business fixed investment by a huge 11.9 per cent. The number in jobs leapt by a remarkable 261,000 persons (2.5 per cent), and unemployment fell to only 4.2 per cent of the labour force by December (and just under 4 per cent by February). Yet a drought-affected farm sector, and a subdued private housing investment sector, were restraining economic growth throughout most of the year. Both are now moving again. It is hard to argue that Labor inherited a lemon.

That's all very well, government spokesmen (and women) now say, but look at the inflationary situation we inherited. It has already given rise to two increases, each of 0.25 per cent, in the Reserve Bank's official cash rate, in February and March. By the time this article is published, the March quarter Consumer Price Index (CPI) figures will have been released, perhaps even leading to a third increase when the Reserve Bank Board meets on May 6.

Throughout 2007, and during the election campaign in particular, Mr Rudd often argued--on the whole, effectively--that Australians were sick of all the "blame shifting" which, he said, characterised the Howard years. Nevertheless, for the past five months or so his government has been assiduously arguing that these interest rate rises--and the inflationary prospects giving rise to them--are not its fault. Rather, it says, they can be directly blamed on the outgoing government.

This article will argue that, while the first claim ("It's not our fault") is broadly correct albeit subject to a caveat or two, the second claim is not. Indeed, the debate over them has been a classic example of trying to play Hamlet without the Prince of Denmark. The missing actor is the Reserve Bank of Australia (RBA). If the inflationary prospect in late 2007 and early 2008 was such as to require previously unforeseen action by the RBA, that can be laid at the door of neither the new government nor the old one, but squarely at that of the RBA itself.

LET US BEGIN with the easy part. Clearly, a government only elected in November 2007 cannot be held responsible in any significant sense for interest rate increases that then occur in February and March 2008. None the less, there are a few caveats which, without dwelling on them, should be kept in mind, not least by Mr Rudd and his Treasurer, Wayne Swan.

While the inflation data emerging so far are clearly a product of past economic events, future inflation prospects are a function not only of those events but also of any inflationary expectations that the new government's election may have generated. As the Statement on the Conduct of Monetary Policy (hereinafter referred to simply as the Statement) agreed between the Treasurer and the Governor of the Reserve Bank, Glenn Stevens, on December 6, 2007, said: "Both the Reserve Bank and the Government agree on the importance of low inflation and low inflation expectations" (emphasis added). Three specific areas of the new government's policies giving rise to future inflationary fears are workplace relations policy, industry policy and climate change policy.