I’m unimpressed at the interest rate rise. I think tackling inflation in this environment is primarily a fiscal task, although I do think restraining the money supply would be helpful. Interest rate rises hit borrowers not lenders, and even borrowers are quarantined if they are not heavily geared, if demand remains high, and if they can lay off costs against income — as do businesses and those who negatively gear investment properties.

This rise will not affect the better off at all — quite the reverse — it makes them more money. For the large percentage of Australians who are cash rich, with low and no debt, an interest rate rise just gives them more money to spend.

What does affect their consumption is exogenous and virtually unaffected by RBA and Government actions – the pressure on financial and stock markets as a result of the sub-prime and credit squeeze.

Particularly given the international environment, I think the case for an interest rate rise was weak. A substantial portion of our inflation is supply-induced. Raising interest rates will do nothing to reduce demand and ease supply pressures and rising costs of food and fuel. And interest rate rises are themselves inflationary, since they raise the cost of capital, which flows into the price of goods and services.

Although it only inferred as much, the RBA may have felt it needed to raise interest rates for another reason. An international credit squeeze that has reduced money supply and forced up the cost of money means Australia faces a more competitive market for money. As we are absolutely dependent on short-term foreign cash inflows to fund our growing deficit, raising domestic interest rates does help.

Nevertheless, the case for Rudd to make a fiscal contribution to reducing inflationary pressures is strong. There are two strands to this. I fear the Government will not address the first, which is reducing asset inflation, which in turn produces a wealth effect, resulting in higher demand and consumption. Increasing land supply, reforming negative gearing, and not parking the surplus in shares would all help. Where is that 1.5% surplus going to go? Putting it into hard infrastructure is not inflationary – just the reverse – in the longer term it increases supply so reducing inflationary pressures.

The second strand the Rudd government will attend to. They wish to reduce government spending and increase the budget surplus as their contribution to reducing inflationary pressures on the Australian society and economy.

Essentially they seek to reduce private and discretionary consumption and reduce demand pressures which contribute to rising costs. They have rightly indicated a policy interest in the supply-side too, eg by investment in infrastructure and by reducing labour costs by increasing productivity based training.

Tackling inflation is important. Reducing government expenditure is a legitimate policy tool to use in doing this. As long as budget cuts are not in areas that are critical to the poor (including proposed measures to increase their real or disposable income); and are not in education training and skills, and investment in infrastructure, (both essential to our future productivity, and that includes climate change spending).

Increasing the budget surplus can be achieved in one or two ways — reducing spending or increasing revenue. Spending can be reduced through cutting waste and political expenditure (i.e. government advertising), and in cutting “non-essential” expenditure. There is less need to cut government services, apart from the obvious support for cutting out pork-barreling, delivering greater efficiency and minimising waste. They are rightly interested in raising productivity through investment in soft (health, education) and hard infrastructure; and they should be interested in increasing revenue – which has the effect of reducing private consumption and demand, and increasing public savings.

Increasing revenue through revenue reform can deliver greater equity as well as greater surpluses. Over the budget cycle of three years, public revenue can be increased and private consumption reduced by deferring or cancelling proposed tax cuts to the well-off; by reducing tax expenditures and by rationalising and capping tax expenditures; by withdrawing tax concessions; or by introducing means testing so that corporate welfare and welfare for the rich is withdrawn or reduced.

Peter Fray

Get your first 12 weeks of Crikey for $12.

Without subscribers, Crikey can’t do what it does. Fortunately, our support base is growing.

Every day, Crikey aims to bring new and challenging insights into politics, business, national affairs, media and society. We lift up the rocks that other news media largely ignore. Without your support, more of those rocks – and the secrets beneath them — will remain lodged in the dirt.

Join today and get your first 12 weeks of Crikey for just $12.


Peter Fray
Editor-in-chief of Crikey