From Peter Martin this morning come this important story:
The head of the Treasury says the Reserve Bank should be prepared to cut interest rates further as the Australian dollar falls, if necessary temporarily breaching its target and allowing inflation to climb beyond 3 per cent.
Martin Parkinson is a member of the Reserve Bank board. The bank’s governor, Glenn Stevens, has signed an agreement with the Treasurer to keep inflation between 2 and 3 per cent ”on average over the cycle”.
As the Australian dollar slid below US95¢ for the first time in 30 months on Thursday, Dr Parkinson told a Senate hearing the bank should ”look through” the inflation consequences of the sliding dollar and continue to keep interest rates low or cut them further even as the falling dollar pushed up prices.
”I wouldn’t wish to speak on the governor’s behalf and as a board member it is always a slightly difficult situation,” he said.
”But they could basically keep interest rates at a particular point, or they could lower them further, and just accept that inflation went out of the band for a period. Then, you know, they could try and stop the second-round effects.”
He was backed by his deputy, David Gruen, who said the Reserve Bank’s ”flexible” target meant it could allow inflation to climb above the top of the 2 to 3 per cent target band so long as it did not spark a wage-price spiral. Inflation is now 2.5 per cent. A sudden increase in rates to contain inflation as the dollar fell could harm the economy and prevent the dollar from falling further. It has slid from US102¢ to US94.6¢ in the past five weeks.
Parko also conceded:
…some of the assumptions that underlay the budget forecasts were out of date when the budget was delivered on May 14, and said he took ”full responsibility”.
”When we were bedding down the budget there were movements in commodity prices and we had to say, ‘Well, what do we do?’ Do we respond to what has happened, or do we sit? We chose to sit, and I take full responsibility.
”With hindsight, I think I would have been better off jumping in the other direction, but it was an on-balance decision.”
Bravo. Both sensible statements. Though I have to ask how the RBA will prevent any second round effects of an inflation spike (read, wages spiral). If it’s not going to hike rates, why, it’s going to need macroprudential tools! Either that, or the government will have to break or persuade the unions to opt out.
Anyway, that is a problem for another day. What Parko has just done is loosen the RBA’s inflation targets so it isn’t forced to destroy the economy with rate hikes as the dollar falls.
