inflation (1 Viewer)

[aussie-boy]

why is it that the RBA is being urged to cut interest rates on Tuesday whilst inflation remains at an alarming high of 4.3%?

the newspaper suggests it is for "cushioning the economy," but what does this mean? surely encouraging spending rather than saving at this point will only add to inflationary pressures and lead to a more unstable economy

 

[Enteebee]

If everyone starts saving their money and stops investing it our economy grinds to a very scary halt.

 

[gnrlies]

why is it that the RBA is being urged to cut interest rates on Tuesday whilst inflation remains at an alarming high of 4.3%?

the newspaper suggests it is for "cushioning the economy," but what does this mean? surely encouraging spending rather than saving at this point will only add to inflationary pressures and lead to a more unstable economy

This is a very good question.

Ive discussed it before in a few threads so you might like to check those out.

But in a nutshell here is the answer:

Firstly, inflation targeting can be thought of as "inflation forecast targeting". So in other words the inflation rate that we have now is an inflation rate that reflects the state of the economy over the last 6 months, and monetary policy settings around 18 months ago. Subsequently the RBA is thinking approximately 18 months ahead. Given the recent global economic events there is expected to be a significant slowdown in economic growth, and we have already seen a fall in commodity prices which will lead into other prices into 2009. So there has been a modification in the projected path of inflation (the RBA essentially forecasts where it believes inflation will be each month over the next two years or so, although they do not publish this formally - sometimes they have forward projections in their bulletins). For this reason there is room to significantly reduce the cash rate (some are saying 50 basis points).

The second reason is because although inflation targeting needs to be a credible policy; it should never be thought of as a rule. Ben Bernanke often talks about inflation targeting as being more of a framework than a rule and this is apparant here. It is not a rule because if it was, it would not give policy makers sufficient flexibility to deal with output variations. Inflation targeting is a form of "constrained discretion" which simply means it allows policy makers to make judgement calls where they see fit. In this case the risk of pursuing a tight monetary policy is seen as having the possibility of doing more harm than good. It could unecessarily prolong a period of slow growth, or worse still put the economy into recession.

Of course providing a nominal anchor for prices is always the main goal of monetary policy, and there is no real place for output stabilisation in the medium term. However in the short term, where stability and confidence can be very important; the RBA has a role to play.

 

[gnrlies]

And in the scheme of things 4.3% isn't that high. Some central banks have an upper point of 5% as their inflation target. Many others have 4%. Ours just seems alarming because we have defined 2-3% as ours.

 

[spence]

And in the scheme of things 4.3% isn't that high. Some central banks have an upper point of 5% as their inflation target. Many others have 4%. Ours just seems alarming because we have defined 2-3% as ours.

And then there's Zimbabwe

 

[Glenjamin]

Don't believe what the papers write because they are only writing what the readers want to hear. The readers don't care about interest rates used to curb inflation. They only care about the lowering of interest rates so they can have more money to spend

 

[Q2C-ME]

which if u think bout it isnt really that much money in the short -term as their disposable incomes are sliced due to the general increase in prices. unless ofcourse their in rampant wage demands...which does not really appear evident in the minor wage index increase

 

[gnrlies]

which if u think bout it isnt really that much money in the short -term as their disposable incomes are sliced due to the general increase in prices. unless ofcourse their in rampant wage demands...which does not really appear evident in the minor wage index increase

Well this is true. In fact given sticky wages (wages will never go down), inflation actually has the effect of lowering costs for businesses as real wages fall. This improves competitiveness and MAY expand production, although this rarely happens as it needs to occur over a sustained period for firms to change their investment patterns (and given a policy committment to low inflation this is even less likely).

 

[8th1da]

Well this is true. In fact given sticky wages (wages will never go down), inflation actually has the effect of lowering costs for businesses as real wages fall. This improves competitiveness and MAY expand production, although this rarely happens as it needs to occur over a sustained period for firms to change their investment patterns (and given a policy committment to low inflation this is even less likely).

Higher inflation does Not reduce costs for business. Real wages is a term described to show how a persons income has increased or decreased after considering inflation. e.g. if inflation is 3.5%, and nominal wage growth is 5% real wages have gone up by 1.5%. This means that businesses are still paying 1.5% more in wages. Furthermore as inflation rises the cost of intermediate goods and services rises, resulting in increased prices for final goods and services(cost push inflation). Hence less demand = less profit.

To answer your question monetary policies main goal is non-inflationary economic growth. However the importance of economic growth must be balanced in the short term, due to the gloabl financial crisis. Although, rates are being lowered demand within the economy is still weak due to the global financial crisis as well as inflationary expectations. Therefore to excel demand and not bring the economy to a halt ( negative as unemployment increases and living standards go down) interest rates must be lowered to create incentive for entrupenurs as well as consumers.

 

[gnrlies]

Higher inflation does Not reduce costs for business. Real wages is a term described to show how a persons income has increased or decreased after considering inflation. e.g. if inflation is 3.5%, and nominal wage growth is 5% real wages have gone up by 1.5%. This means that businesses are still paying 1.5% more in wages. Furthermore as inflation rises the cost of intermediate goods and services rises, resulting in increased prices for final goods and services(cost push inflation). Hence less demand = less profit.

To answer your question monetary policies main goal is non-inflationary economic growth. However the importance of economic growth must be balanced in the short term, due to the gloabl financial crisis. Although, rates are being lowered demand within the economy is still weak due to the global financial crisis as well as inflationary expectations. Therefore to excel demand and not bring the economy to a halt ( negative as unemployment increases and living standards go down) interest rates must be lowered to create incentive for entrupenurs as well as consumers.

Inflation refers to a general increase in prices. So yes, it could be true that input costs rise, but only in a nominal sense. Firms respond by raising their prices. But the point I was making is that the nominal effect (or in this case money wage growth) is not what matters for a business. What matters for a business is real wage growth. In fact you made the point yourself.

If inflation is 5% and nominal wage growth is 3.5%, firms are better off are they not? Firms can charge 5% more for their goods and services which offsets any other factor price increases. But if wage growth is only 3.5% then firms pocket the difference (due to falling real wages). But of course as I said this will only change investment patterns in certain circumstances which are rarely observed.

This is a common analysis of money and real wages.

As for the second part of your post, it really is important to stress that monetary policies main goal is to keep inflation low. Growth has nothing to do with it. Monetary policy cannot be used to stimulate growth in the long run so it plays no role in Monetary policy. You are correct though by stating there needs to be flexibility in the short term. This is why inflation targeting should be thought of as a framework and not a rule, and in this case monetary policy is being used to improve confidence (by attempting to stimulate growth).