The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Thursday, February 17, 2011

Inflation expectations are a rate trigger

In his speech today, the RBA's Dr Phil Lowe has again highlighted how some consumer prices are falling in an attempt to convince households that current inflationary conditions are not all bad. This follows a belabored attempt at the same in testimony to Parliament last Friday, and Ross Gittins yesterday (see post below). Have a close read of the RBA's statements to Parliament:

"The assumption we are making in being able to have that analysis is that people’s expectations of the permanent inflation rate do not go up. I do not think they will actually. We have seen these sorts of things before. People understand that. People correctly sense that prices of fruit and vegetables and so on are going to go higher for a while. The damaging thing would be if they took that to mean that inflation everywhere is going to stay high permanently. Then we have got a problem, because it is not so easy then to say that monetary policy should not respond to that. It would have to if that turned out to be the problem.

- Posted using BlogPress from my iPad

So that is why it is important for us to help people understand the temporary nature of things, and that is why we have set this out in some detail in the document. We can appeal, of course, to the Cyclone Larry experience, where banana prices went through the roof but a year or so later they were back to normal. That is what we need people to understand. So our job—those of us who comment on inflation—is to help people understand this point. I think we have got a pretty good chance of doing that, because, in the past episode, people expected inflation to be higher for a while but they did not expect it to stay higher permanently. That worked out well. I would be pretty confident we can achieve that again. We just have the job to do to explain...

People do, though, tend to overlook prices that fall a little bit and 30 per cent of the CPI items actually had a negative price change in the latest quarter. There are certain things that people do not buy quite as often as the weekly groceries and it is human nature that we tend to forget that those prices go down in many instances. So I think that is a factor and it is understandable. But, in the end, the consumer price index samples 100,000 prices every quarter. There is a far better sampling there than any of us could do by keeping a casual tab on our grocery bill—which we all do. Certain things are quite prominent, of course—petrol and things like that. But I think the CPI is probably amongst the most reliable statistics that the Bureau of Statistics puts out because, as I say, they do a very large sample. But there are differences in experience, because the CPI is calibrated for the average household living in a metropolitan area and none of us are actually quite average, are we? Any given person, probably quite rightly, will find that, if they could measure their own basket exactly right, it would not be quite the average experience...

Dr Lowe —Yes. The prices of many goods at the moment are declining. If you go through the CPI over the past year, you see that the price index for clothing is down six per cent, the price index for major household appliances is down four per cent, the price index for audiovisual equipment is down 18 per cent, the price index for furniture is down two per cent and the price index for linen, manchester, is down around two per cent. Almost all the goods in the CPI are down quite significantly. I think many people, because they do not buy these goods on a regular basis and have in their mind a clear concept of what the actual price is for a shirt or some Manchester, do not feel price declines but they are real and they are happening. What people are noticing is the higher price of utilities in particular. The price index there is up roughly 10 per cent over the year and people really notice that when they get their electricity bill. That is affecting many people’s perceptions of what the true cost of living is doing."