The Reserve Rank’s statement on monetary policy released yesterday wasn’t comfortable reading for those hoping to see interest rates level off and start falling.

“There … remains a risk under the current monetary policy setting that demand does not moderate sufficiently to achieve the forecast reduction in inflation,” the RBA said. “On the current outlook, then, and allowing for the inevitable uncertainties in forecasting, the risk of inflation remaining uncomfortably high for some time is considerable.”

One of those uncertainties is the impact of the Rudd Government’s promised tax cuts — $7 billion for the next financial year. Writing in today’s Age, Kenneth Davidson notes that, “In round terms, interest rates must be increased by half a percentage point to cut expenditure by $7 billion …”. That’s an uncomfortable equation for Messrs Rudd and Swan.

If the tax cuts proceed, what can be done to satisfy the RBA’s concerns over inflation? And if controlling inflation is at the top of the government’s list of economic things to do, can it afford to go ahead with the planned tax cuts? Crikey asked a group of leading economists.

Associate Professor Steve Keen, University of Western Sydney. The RBA’s concerns about inflation are overblown. I’m one of the critics of what I see as their obsession with keeping inflation low, and that’s for two reasons. One is worrying about inflation now while ignoring the level of private debt, which is a bit like worrying about somebody having a cut finger while they’re simultaneously being crushed by a truck. I’d rather get the truck off their chest. The other thing they believe is that raising the interest rate will reduce the rate of inflation. But we need to remember that we have had insane housing and rental policies. As a side effect of those, if you take a look at the last CPI figures, the two biggest causes of inflation are increases in housing costs and increases in financial services costs, and the rate of interest feeds directly into both of those. Because the RBA is obsessing about the rate of inflation, about the only thing the government can do would be to redirect a large portion of those tax cuts into something that doesn’t involve current expenditure. I like the idea that Ross Gittins floated a couple of days ago about making it a superannuation trade-off. This takes the money out of current expenditure, and removes one reason the RBA has for obsessing about the rate of inflation.

Paul Brennan, Head of Economics, Citigroup. This year’s proposed tax cuts aren’t as stimulatory as last year’s tax cuts. I think they could still go ahead with the tax cuts but what they will have to do is look at fairly significant expenditure savings in other areas so that the overall fiscal position isn’t unduly adding to interest rate pressures. The government’s talking about a 1.5% budget surplus which sounds about right to us. I’m not overly concerned that the tax cuts will lead to more interest rate rises. If you look at the RBA’s inflation forecast, they don’t actually have inflation accelerating further after the tax cuts. It doesn’t seem to be their view that tax cuts will lead to even more inflation. Last year was probably the year when the tax cuts added most to the strength in the economy and inflation pressures.

Chris Caton, Chief Economist, BT Financial. The tax cuts are going to go ahead and that’s a political decision, I think, more than an economic one, but you can’t make promises and then not keep them. It just makes the Reserve Bank’s job at the margin a little more difficult to the extent that it stimulates growth while they’re trying to reduce growth. It’s my view that we may finish up with one rate rise more than we would otherwise have had if the government abandoned the tax cuts. But breaking a political promise like that is something very difficult to do, I imagine.

Shane Oliver, AMP Capital Investors. In an ideal world, thinking in terms of pure economic policy, it would be better not to have the tax cuts, and the same could be said for the tax cuts of the last few years. The basic problem is that Australia has had a massive boost in national income over the last five years thanks to the resources boom, which has injected a lot spending power into the economy. Ideally, the government should have been squirreling away a bigger government surplus over the last few years, and we should have forgone the tax cuts. But it’s not an ideal world and you’ve got to take into account the politics, and if you get a bigger and bigger budget surplus, someone sooner or later will want to come along and spend the money and they might do it less wisely. But weighing up all the arguments, I think tax cuts have contributed to inflation in recent years, but only at the margin. It would be wrong for the government to cancel the tax cuts entirely. The electorate is already cynical about election promises, but one way of minimising their impact would be to convert it to superannuation, which helps reduce spending power in the economy, among other things. That at least puts away some of the money away.

Peter Fray

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