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Are Interest Rates Driving the Economy into Recession?

Economics / Austrailia Feb 11, 2008 - 12:11 PM GMT

By: Gerard_Jackson

Economics Interest rates are rising and it looks as if the Rudd Government is beginning to panic, a sign of which was Treasurer Wayne Swan's silly threat to banks not to be greedy by raising interest rates. This would be funny if it were not so serious. It is abundantly clear that our Treasurer is at a complete loss to understand what is really happening with interest rates. Unfortunately for Australia the same can be said about our economic pundits.

Tim Colebatch argued that because the ratio of unemployed had fallen from 25 to 2.5 this helps build the Reserve Bank's case for higher interest rates. ( The Age , Case builds for rates to rise again , 10 January 2008). According to Alan Wood Australia's problem is that "growth is running too strongly for comfort". ( The Australian , US slowdown won't curb our inflation , 30 January 2008). Economic growth means capital accumulation. Therefore to argue that we are growing too fast is to argue that we are getting rich too quickly. As supplies constituent demands they must both be equal. It therefore follows that what has really been growing is the money supply, the very thing these pundits avoid mentioning.

That money supply is the key to the problem was revealed by Glenn Stevens, the RBA's governor, when he warned that domestic demand would have to be curbed if inflation is to be defeated. But what does he mean by domestic demand if not the money supply? A quick look at the RBA's assets and its monetary aggregates tell the real story. From March 1996 � when Howard won his first election � to November 2007 bank deposits rose by 224 per cent and M1 by 200 per cent. One would have to be utterly blind to these facts � which is definitely the case with our economic commentariat � to imagine that this reckless monetary growth has had no impact on the economy.

The RBA's assets and monetary figures strongly suggest that Stevens means what he says. Last June M1 peaked at $226 billion, rising slightly to $226.4 billion by November. Bank deposits peaked at $188 billion in June, dropping to $181.4 billion by July and then rising to $187 billion in November. Assets topped out at $135,216 million in May, falling to $92,812 million in December. At the same time the targeted cash rate has been rising. It now stands at 7 per cent. Targeted means just that — targeted. In order to reach it the RBA must suck money out of the banking system. And this is the story that the bank's fall in assets and the virtual freezing of the money supply � at least up to last November � is telling us.

What is really bad is that our economic journalists � despite what they think � are utterly ignorant of genuine monetary theory and even the very nature of money. Thanks to their conceit the important issue of monetary policy cannot be seriously discussed in Australia. Meantime, Kevin Rudd, our glorious Prime Minister, has been persuaded that he can use surpluses to fight inflation. He is unaware of the fact that the surpluses that Howard and Costello bragged about were actually created by the RBA's inflationary monetary policy.

Nevertheless, Rudd has declared that he intends to follow through with his promised tax cuts. This has led some economists to argue that by returning more than $6 billion dollars to taxpayers the effect of interest rates in slowing the economy will be neutralised. This would only be true � and then only to a certain extent � if the tax cuts come out of 'idle' deposits with the RBA and not cuts to government spending. Moreover, these economists are overlooking the important fact that at the moment the RBA seems to be sucking money out of the banking system. An additional $6 billion or so would be a temporary hiccup.

So while the RBA is busying itself with the economy our politicians are once again displaying their glaring ignorance of economic theory. Brendan Nelson piously declared that it was wrong of Labor to blame the Howard government for rising prices. Nelson is not entirely in error. It is true that the RBA is responsible for monetary policy. It is equally true that Nelson, Costello, Turnbull, Minchin � in fact the whole bloody bunch of them � resolutely refused to inform themselves on economic matters. In this respect they are truly culpable. Furthermore, Nelson's claim that "Mr Rudd and Mr Swan inherited an economy in first-rate condition" is arrant nonsense.

On the other hand, Treasurer Swan's posturing and Rudd's economic declarations are strong hints that in this respect they have every intention of being as bad as the Liberal Party. Malcolm Turnbull's opinion that Swan is exaggerating the threat of inflation is further proof that when it comes to economics the Liberals really are the hopeless Party and will remain so until they decide to educate themselves on economic matters. Unfortunately, by deliberately denying informed Liberals a forum to exchange views Kroger and Costello successfully sabotaged any possibility that the necessary education will ever take place.

By Gerard Jackson

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

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