Explain to me like I'm 10 years old why inflation resulting from high fuel prices can be managed by increasing interest rates?

Who says it can be ?

Some years ago the RBA was made independent of government and given the simple task of adjusting interest rates in respect of inflation (and employment).

Problem is they have one task, but only one tool to do it, and they are the only ones directly responsible for it.

So it is irrelevant what the effect or relationship between RBA interest rates and the price of a basket of consumer good is. RBA has one tool and one task. So they have to raise or lower the rate even if it makes no difference and even if they know it makes no difference.

There are many other ways of reducing inflation that many other people could employ. But they don't, because it is way easier for them to just blame the RBA and tell you the RBA is 'independent'.

The RBA rate decision being independent of politics is great, but that shouldn't mean politics is independent of the RBA rate decision.


In simple terms for a 10 year old MSN, it is because there are many leaners but only one lifter. And the lifter isn't given anything to lift, but the leaners have convinced everyone else it is all the lifters job, and only the lifters job.



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Carantoc said..
Who says it can be ?

Some years ago the RBA was made independent of government and given the simple task of adjusting interest rates in respect of inflation (and employment).

Problem is they have one task, but only one tool to do it, and they are the only ones directly responsible for it.

So it is irrelevant what the effect or relationship between RBA interest rates and the price of a basket of consumer good is. RBA has one tool and one task. So they have to raise or lower the rate even if it makes no difference and even if they know it makes no difference.

There are many other ways of reducing inflation that many other people could employ. But they don't, because it is way easier for them to just blame the RBA and tell you the RBA is 'independent'.

The RBA rate decision being independent of politics is great, but that shouldn't mean politics is independent of the RBA rate decision.


In simple terms for a 10 year old MSN, it is because there are many leaners but only one lifter. And the lifter isn't given anything to lift, but the leaners have convinced everyone else it is all the lifters job, and only the lifters job.



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What are the many other ways?

Look up "Cost Push" inflation. Both Demand Pull and Cost Push are managed the same way....increase the cost of money to reduce the want to spend.

Admittedly Govt spending through Fiscal policy is also an effective tool, however much slower acting than Monetary policy. Plus Fiscal policy buys votes.

hilly said..

What are the many other ways?

Well, I believe we have had this discussion before.

In simple terms, for a 10 year old, too many to list. But one biggy is altering the supply and the demand of everything. RBA doesn't really directly supply much or take much as demand. But just about everyone else does.


In more nuanced terms it depends on what you believe 'inflation' is and, as sh ithouse says, whether you are talking short term (monthly or quarterly) or longer term (annually or 3 year election cycle).

I assume we are talking about the CPI published monthly by the ABS (a basket of typical goods consumed by a typical household www.rba.gov.au/education/resources/explainers/inflation-and-its-measurement.html) and short term effects linked to media headlines about the RBS monthly meetings.

The RBA has a responsibility to adjust it's interest rates to get that mathematical calculation to equal a pre-set result.

But us consumers are each individually, and also as a collective, not necessarily effected in a direct 1 to 1 ratio with this published CPI figure. So should we be talking about the mathematics of the CPI statistics, or the general cozze livs situation the media is going on about ?

About 20% of the CPI basket is government services. So if you wanted to directly fiddle the statistics you could reduce the cost of those services. You could then put the same increase into other government revenue that doesn't sit within the CPI basket. Net result is no change to government income, no change to citizen expense but CPI basket cost goes down. You could of course also do the opposite. And eventually the ABS will adjust what is in their basket, so it wouldn't work forever but it might be enough to help an election campaign.


For the sake of the discussion I'd also like to throw in the notion that it is crazy to beLIEve that it is viable or sustainable for interest rates to be below inflation rates. If they are then debt can be repaid simply by waiting. So irrespective of what forces are at play there has to be some macro-economic correction for the post-COVID years where crazy government and central bank policy made the cost of debt below the cost of inflation.

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