Former Reserve Bank governor Bernie Fraser has come out against further interest rate rises, citing exogenous shocks as the main source of inflation instead of the demand driven thesis normally given by the main stream media (msm):

The target band may need to be reviewed if the climb in food and fuel costs reflected structural changes in the global economy rather than the regular ebb and flow of prices.

“We’re not there yet but the question is going to arise, are some of these increases not seasonal, not episodic, but structural and secular?” Mr Fraser has told The Australian Financial Review.

“If we’re going to be faced with secular oil prices, that’s going to directly and indirectly push up inflation.

“But it would be wrong, in my view, for the Reserve Bank to respond to that sort of increase in inflation by pushing up interest rates.”

In other words, supply side shocks are affecting inflation and these factors are not best addressed by monetary policy, although as I have written before, the current money supply policy is making inflation worse. By contrast, demand in the economy has slackened off considerably:

Consumer confidence is close to a 15-year low and growth in retail spending ground to a halt in the first three months of the year…Business, too, is hurting from rising borrowing and fuel costs, forcing them to cut back on their hiring intentions and rein back on upgrading their facilities and infrastructure investment as sentiment dropped to the lowest level since 2001.

So if the current rate of inflation is not driven by demand, what is one to make of the msm coverage given to a tax cut – inflation link? Basically that the view is shallow, fed by the hard left in the media that are opposed to any reduction in Government revenue for fear of Government becoming irrelevant and in some way hurting the club for victim hood. The CIS has a less cynical take on the issue than my view:

Reductions in taxes can be useful in inducing increased labour supply. But the benefits of tax cuts extend well beyond their positive implications for labour supply, to issues relating to the distortions, compliance and collections costs that flow from the operation of the tax system.

Tax cuts have the capacity to increase supply more broadly, not just in the labour market, easing capacity constraints and reducing inflation pressures.

The appropriate focus for fiscal policy is precisely these microeconomic and supply-side issues, not demand management.

I also have another proposition. Tax cuts provided in the past were merely keeping up with inflation by reducing the rate of the ‘inflation tax’ or bracket creep. In order to help remediate the current rate of inflation, caused by supply-side constraints, larger tax cuts are need above and beyond the inflation tax. This will stimulate the supply side signals needed for the market to reduce the current rate of inflation through investment in productive capacity, continued expansion of the labour market and encouraging savings.