Reserve Bank of Australia (RBA) governor Glenn Stevens’ reminder about the damage high inflation caused to the economy in the 1970s suggests the central bank remains ready to lift interest rates further.
Mr Stevens said the RBA’s target to maintain inflation with a two to three per cent range over the course of the economic cycle was the best system to keep prices down.
He said Australia’s price pressure problems now were not as bad as in the 1970s.
“Even with the recent surge in consumer prices taking the inflation rate to a bit over four per cent, things are not like there were in the 1970s,” Mr Stevens told a University of Sydney alumni dinner last night.
Mr Stevens said inflation could rise to 1970s-type levels if the target band – which came in for criticism today from former federal opposition leader John Hewson – was not obeyed.
“It’s easy to say `why not raise the target?’,” Mr Stevens said.
“That was the previous thinking of the 1970s. That’s how we got 10 per cent (inflation), it’s too big a liability.”
Between 1970 and 1979 the average rise in the CPI was 10.7 per cent a year, which eroded the value of money by 60 per cent over the period.
At the Mortgage and Finance Association of Australia national convention in Sydney today, Dr Hewson questioned the validity of the current inflation target and said RBA had “already gone too far” in raising interest rates in February and March.
He said the target was “not necessarily the magic target range” because there were a lot of factors such as rising food, oil and commodity prices which the RBA “can’t control through interest rate adjustments”.
“To my mind, at least the last two (rate) increases were unjustified,” Dr Hewson said.
Dr Hewson said pushing up interest rates to control inflation was like “using a sledgehammer to tune a Ferrari”.
JP Morgan chief economist Stephen Walters said the governor’s speech indicated rate cuts anytime soon were “out of the question”.
“The governor referred to the corrosive impact of persistently high inflation in the 1970s and the very high price that had to be paid after policy makers had helped to facilitate high inflation becoming entrenched in corporate pricing decisions and wage negotiations,” Mr Walters said.
“Clearly, one interpretation is that the RBA does not want a repeat of this painful experience.
Mr Walters said higher food and energy prices, as well as price increases triggered by this week’s federal budget, meant near term risks to inflation were “skewed to the upside”.
“The main message from the speech is that the RBA is on hold but, with inflation already well above target, the emergence of sustained evidence that domestic demand is not slowing in line with expectations could trigger another rate hike,” Mr Walters said.
The RBA said in its quarterly statement on monetary policy last week it expected an annualised underlying inflation rate of 4.25 per cent by June and four per cent by December.
It also projected underlying and consumer price inflation (CPI) to decline gradually in 2009 to around 3.25 per cent before falling to three per cent in 2010.
Mr Stevens has previously rejected suggestions by some commentators that the central bank should raise its inflation target band.
“I do not think that the two to three per cent average inflation target is too ambitious,” he said in March.
“We have achieved it for the past 15 years and we achieved average outcomes of that order for long periods in the 20th century.”