There’s been a lot written about the economy, interest rates and jobs in recent months as the Reserve Bank has sought to clip an inflationary break out before it gets too entrenched.

The RBA has been accused of being out of touch and needing real people on the board. Malcolm Turnbull has even accused the Rudd Government of “egging on” the board to lift rates.

Well, everyone should sit down, have a cup of tea and read the speech given by RBA Governor Glenn Stevens to a seminar held by Federal Treasury in Canberra on Tuesday. That includes you, Mr Turnbull.

After a long explanation about the inflationary position, including a forecast that the March quarter Consumer Price Index will hit 4% or more (and the bank won’t lift rates), and the pros and cons of monetary and fiscal policy, Stevens offered what turned out to be a bullish assessment of how Australia is travelling.

It should be required reading for all the hyperactives who see an inflationary ogre in every petrol pump:

The above remarks address some reservations about the conduct of monetary policy that I have seen of late. Some of these reservations are understandable, but there are reasonable responses to them. It should also be observed that it is not the first time we have seen most of these arguments: they tend to recur each time we reach the top end of the inflation cycle and monetary policy has to control it.

Having said all that, it is important to keep some perspective about the situation in which we find ourselves. We have been living through one of the largest transformations in the structure of the global economy, as far as Australia is concerned, for a century. The rise in the terms of trade over the past five years is the biggest such event since the Korean War boom in the early 1950s. But while the Korean War event was a temporary one, all the indications are that the rise of China is not just a cyclical event, but a structural change of the first order. China certainly has a business cycle, like all other economies, and will slow at some point. Even so, it is highly likely that, short of some catastrophic event, China has many years of strong growth still ahead. It will not be at the 11 per cent per annum pace of the past couple of years, and there will be periods of weakness and instability. But the rise of China is not a flash in the pan of economic history.

In essence, we are seeing a very large change in relative prices in the world economy, and a relative price change that is more important to Australia, in particular, than to almost any other country. These sorts of events will always produce stresses and strains, including significant divergences in performance across industries and regions (though these are often exaggerated in popular discussion). Because the event is, overall, very expansionary, it was always likely to be associated with some risk of higher inflation.

But given the magnitude of the shock, when all is said and done, the economy has coped pretty well so far. Yes, inflation has risen. This is a problem, and requires a suitable response from monetary policy. But compare the outcomes on this occasion with those in the commodity price booms of the early 1950s or the mid 1970s. In the early 1950s, CPI inflation reached 25 per cent, then fell back to zero within a few years, associated with quite a pronounced recession. In the mid 1970s, inflation reached about 18 per cent, and took a very long time to come down to acceptable levels. This time, we are grappling with a peak CPI inflation rate that looks like it will be around 4 per cent in CPI terms, and trying to assess how soon it can reasonably return to 2‑3 per cent. This is a far cry from the problems of yesteryear.

The reason we are doing better this time around is not hard to fathom, either. As work in the Treasury has argued persuasively, a flexible exchange rate, a reformed and flexible industrial environment, better private‑sector management and much stronger fiscal and monetary policy frameworks have made a lot of difference. The fruits of those decades of effort of reform are an economy that, for all its strains, is doing well under the circumstances.

Peter Fray

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