The release of the Australian National Accounts [1] on Wednesday [Sept 3, 2008] confirms what most Australians already knew, a rapid slow down in domestic economic activity. In seasonally adjusted terms GDP increased by just 0.3 per cent in the June quarter. Excise investment in machinery and equipment in Western Australia from the result, and you get zero growth for the quarter.
Notwithstanding a rapid slowing in the economy, a pre-occupation with an ageing inflation target has been maintained. A pre-occupation with this 15 year-old inflation target has muzzled the adoption of a monetary policy that maintains a ‘realistic' inflation target. Such a target should be mindful of external price shocks and capacity constraints within the Australian economy.
To suggest that inflation woes experienced over the last 18 months were a consequence of consumer exuberance ignores the fact that investment in capacity building infrastructure has been sadly lacking for quite some time. Furthermore, it ignores the effect of external price pressures most notably the price of oil.
Monetary policy has not just slowed the economy it has all but stalled activity at a time when investment is desperately needed. There is no problem with using an inflation target as a nominal anchor, but after 15 years it is time to review the target in light of internal constraints and external pricing pressures.
Earlier in the year Australians were effectively told to tighten their belts. This advice ignored the fact that significant prices increases were being experienced in respect to fuel, groceries, fuel, rents and mortgage repayments. Hard to reduce spending on life's essentials. Price pressures in these goods did not reflect an indulgence on behalf of consumers, but rather increases in the cost of production due to increases in energy and commodity pricing along with labour shortages.
Clearly there was a requirement during 2007, to consider in more detail the contribution of external factors (including the price of oil and other commodities) and internal capacity constraints and their relative contributions to inflationary pressure. This consideration should have been used to devise a new inflation target, one that retains discipline but at the same time is mindful there are some external and internal pressures that need to be viewed over the longer term.
The effect of a restrictive monetary policy on investment in the private rental market provides a useful lesson. Rate rises have starved investment at the same time demand has increased (a consequence of population growth) add to that record low vacancy rates is it any wonder that rents across the country have increases in the order of ten plus percent. Then consider that the relative weight of private rents to CPI is just over 5 per cent and the impact of restrictive monetary policy in a capacity constrained economy becomes obvious.
Maintaining economic and employment growth must remain the top priority. Investing in capacity building and providing an appropriate environment to encourage this investment must surely be a close second. Less important is a rigid adherence to maintaining an inflation target devised 15 years ago.
Chris Lamont is the Chief Executive - Policy for the Housing Industry Association [2]. He is an economist with previous experience in both the public and private sector. Prior to joining HIA he was a Chief of Staff to a former Federal Minister. In 2008 he was appointed by the Prime Minister of Australia the Hon. Kevin Rudd to the National Housing Supply Council.