freediver wrote on Jun 15
th, 2008 at 7:00pm:
Welcome to OzPolitic John.
Thank you.
freediver wrote on Jun 15
th, 2008 at 7:00pm:
I think this is a bit of an oversimplification. It is unsustainable growth that puts pressure on inflation. The goal of the reserve bank is not to prevent growth, but to limit it to what is sustainable. This is usually regarded as being when inflation is between 2% and 3% per year. I think that inflation is a good indicator of how the short term economic growth differs from the long term sustainable rate of growth.
There is no valid explanation as to why economic growth of any kind would cause price inflation. By definition this is a contradiction. Rather, unsustainable economic growth and price inflation are symptoms of the same thing: monetary expansion.
When newly created money enters the economy, investors and consumers are given false signals: that there is more money than exists and that there are more investors with more savings they are willing to lend. This isn't the case - there isn't that much money, there aren't that much savings, and the money is being created from thin air. Initially, production speeds up and unemployment drops as the new money is thrown around, but this is unsustainable when shortages of capital and labour emerge. Eventually, prices will rise to reflect this, and the Reserve Bank will be forced to react to increasingly apparent CPI increases resulting from this phenomenon. The businesses that relied on loosely available money at low interest rates will become inviable, and the economy may go into recession. Resources were wasted and goods and services were provided when they didn't need to be. Perfect example: property speculation, which, unfortunately, many people still blame negative gearing for.
freediver wrote on Jun 15
th, 2008 at 7:00pm:
Anyway, what the reserve bank is actually trying to do is stop economic growth becoming cyclical. Up until about fifty years ago, economic growth was marked by strong boom-bust cycles. The great depression was one of the 'bust' times. It was not a one off event, but part of a series of such cycles.
Yet, ironically, it is central banks that predominantly cause the business cycle. There was no need to establish a central bank in the first place.
The great depression occurred due to rapid monetary contraction.
freediver wrote on Jun 15
th, 2008 at 7:00pm:
I think part of the reason for this is that there is so much psychology involved in the market place. This leads it to irrational highs and lows, when the public is way too confident (ie borrows too much to invest) or way to skeptical (refusing to invest or take any risk).
Share markets may be psychological day to day, but the economy isn't. People still need to consume, trade, and produce.
Without a central bank's intervention, nobody can "borrow too much" for the same reason they can't "buy too much" of anything else - because it is scarce. Thanks to central banks, money isn't scarce when it can be created from thin air, and hence, people
can "borrow too much", fuelling speculative bubbles.
freediver wrote on Jun 15
th, 2008 at 7:00pm:
So what the reserve bank does is hike up interest rates to slow down borrowing when the market is too 'hot', then drop interest rates to encourage borrowing when it gets too cold. Like a shepherd guiding a flock of sheep. We still get economic cycles, but they are no where near as bad as they used to be. They are just small fluctuations around the long term trend in growth.
They follow the wrong figures and manipulate the wrong things. Instead of responding to the money supply, they actually set the money supply to target interest rates to target the CPI, which is a poor indicator of real inflation.
It's not interest rates that allow for increases in spending, but the very thing they use to set interest rates - money creation.
If the money supply was fixed and didn't expand, interest rates would set themselves.
Simply put, it all comes down to the money supply. Significant increases in the money supply spark unsustainable growth patterns, bubbles, malinvestments, and eventually price inflation.
Expansion of the money supply is not necessary for economic growth.
freediver wrote on Jun 15
th, 2008 at 7:00pm:
This is only half the story. If the economy is growing rapidly, more people will be borrowing to invest. This will push up the price of money (ie, interest rates).
It won't push it up as high, because in order for a greater quantity of money to clear (be borrowed), it needs to come down in price. Unless there was a shortage in the first place (ie. if interest rates were too low for the quantity of money available), extra money can't clear for the same price because it is simply not as valuable as the first lot was or there aren't as many people who can afford it at that rate.
freediver wrote on Jun 15
th, 2008 at 7:00pm:
Rapid growth does put pressure on inflation.
I still haven't heard an explanation for this.
As far as I'm concerned, the more rapid an economy's growth, the faster prices fall.