Want Lower Interest Rates? Eat Less

Last Updated May 4, 2010 2:04 AM EDT

Australia's inflation is being driven by rising costs, not because we're out on a spending spree. So if its not increased demand for goods that's pushing prices up, why does the Reserve Bank (RBA) keep on insisting on putting up interest rates?
Monetarist theory tells us when we spend too much the RBA should step in and push up interest rates to quell our frivolous habits. Fair enough. Yet the consumer price index (CPI) rose 2.9 percent over the last year, well below the UK's 3.9 percent inflation rate. Our interest rate has just gone up to 4.5 percent, theirs is 0.5 percent. The US has an inflation rate close to ours, yet their interest rate is even lower than the Poms, at 0.25 percent. Why is ours so much higher? Because overseas they realise that part of the rise in prices is driven by supply-side cost increases.

Whether the RBA has realised it or not (and surely they must have), the same thing is happening here. Food accounts for 16.4 percent of the basket of goods on which the CPI is based. Four years ago it contributed 15.7 percent to the total. We're not eating that much more, it's just that prices have gone up. If you want them to come back down suppliers will have to become desperate and take a margin-cut. So eat less and perhaps send the RBA an emaciated photograph of yourself.

Housing & food have the biggest impact of CPI rises
Another big hit we're taking is in utilities, which now takes another 0.8 percent of the total CPI "basket". Again, it's hardly a discretionary item. The items we do have a choice over are taking a smaller slice of the pie --- motor vehicles down 1 percent, recreational items down 0.9 percent, nice things for the house (like furniture, appliances and the like) down 0.7 percent.

And here's the real sting in the tail. Housing un-affordability is driving more people to rent rather than buy. Rent accounted for 5.2 percent of the CPI four years ago. It's now up to 5.8 percent. The RBA's answer has been to push up interest rates which, in a tight housing market, translates to higher-priced rentals. So they're pushing interest rates up to reduce inflation which is, in part, being driven by higher interest rates. Now that's circular logic!