There's an alternative to reliance on spending cuts

Letter

The Australian

25^th January 2008

Alan Wood ("A shocker, with aftershocks likely", 24/1) points to the dilemma faced by the Reserve Bank in having to increase interest rates here when the US Federal Reserve (and the Bank of Canada) are cutting them. But he also rightly says "if inflation has got away, which it has, the blame lies ultimately with the RBA".

One question that has to be asked is whether the policy of small, step by step increases in interest rates needs changing. This policy has been operating for a number of years and its effects on restraining demand may have diminished. There is a so-called Goodhart's law that suggests that economic behaviour may change after it has become used to a target (in this case dealing with inflation in small doses).

Indeed, although rates have been increased over the past two years, this does not appear to have reduced the annual growth in credit, which jumped from 13.4% in the year ended November 2005 to 16.2% in the year ended November 2007, or in domestic demand. Although changes in growth in monetary aggregates are no longer the determining factor in deciding changes in monetary policy, this suggests the need for a substantive review of the basis of policy.