The Australian
economy is set to continue its strong growth. It has shrugged off a period of
weakness, unemployment keeps falling, business investment is surging and
consumers are spending again. Monetary policy needs to be
tightened.

Just before mid-May,
global markets experienced a period of severe volatility. The most important
reason seemed to be apparent inconsistency in new US Fed Chairman Ben Bernanke’s
views about inflation. When the dust had settled Bernanke’s concerns about
inflation were clear but apparently some of his Fed open market committee
colleagues felt he had pre-empted their decision-making and made strong speeches
themselves. The Fed’s late June policy statement was softer than then expected
and markets rallied.

There are lessons
here for the incoming Reserve Bank Governor. The gossip has had Deputy Governor
Glenn Stevens as clear favourite but lately the name of Treasury Secretary Dr
Ken Henry has been mentioned.

We shall await the
relevant announcement. Meanwhile, what has been happening in the real world?
It has become clear that global demand is still too strong for comfort and
global interest rates are more likely to rise than to fall in the remainder of
2006.

Australian economic
statistics suggest strength rather than weakness. Housing activity is picking
up. Consumer confidence has recovered somewhat as memories of the most recent
interest rate hike fade. Most spectacular has been the reduction in the
official rate of unemployment below 5%. However, as general consumer demand
revives, housing begins to pick up on top of strong business investment and
strong government spending, the case for at least one more rate increase will
become compelling.

Henry has no doubt
that Ian Macfarlane will be seeking to hold off a further rate rise until his
deputy gets the nod as his successor. After such a decision there would be a
more or less immediate rate hike, with a second one to come once Stevens was
firmly in the driver’s seat. Henry will get no thanks for saying so, but
Stevens is far more of a traditional central banker than Ian Macfarlane, or Ken
Henry for that matter.

Should Ken Henry get
the job, a second rate hike would be far less likely. But a rise in
inflationary pressure would be more likely. Eventually of course, the pressures
to hike rates would overwhelm Dr Henry’s natural soft-hearted instincts, since
as Reserve Bank governor he would not wish to be remembered as the man who gave
away Australia’s low-inflation
reputation.

The Treasurer can
foresee these scenarios and no doubt others Henry cannot imagine. His judgement
about the RBA governor is likely to depend on whether, or indeed when, he hopes
to contest an election as Australia’s Prime
Minister.

More reading at
Henry Thornton.

Peter Fray

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