Monetary policy isn’t enough to control inflation

Ahead of tomorrow’s Reserve Bank interest rate decision comes another example of the futility of relying on monetary policy alone to try to control inflation triggered by events outside of the country.

A surprise production cut from OPEC and its mates in Russia has underlined the stupidity of the “wages spiral” labour market demand theories spouted by central banks, economists and a conga line of conservative governments (not to mention the “experts” in the business media).

The cut of 1.16 million barrels a day (or more than 1% of total global demand) boosted oil prices Monday and pushed world oil prices up 7% in electronic trading on the world’s major oil trading platforms.

While major producers like Saudi Arabia, Iraq and the UAE will cut production, Russia says it will merely continue the 500,000 barrel-a-day cut announced unilaterally in February. Russia in fact has not cut its production with the rest of the group and its half-a-million barrel reduction seems to have been matched by falling sales.

That was after world oil prices fell by between 5% and 7% in the first three months of 2023, and have now returned to where they were at the start of the year.

The price rises, if they flow on to prices of key products like petrol and diesel, will have the potential to bring the recent easing in inflation rates to an end.

The sharp rise in prices and threat to boost inflation raises an important question: how can central banks and governments control inflation with monetary policy alone when any inflationary impact of cuts would be supply driven, and so beyond the ability of interest rate cuts?

The surprise cut is a signal that Saudi Arabia sees global demand weakening as rate rises in the developed world continue to slow activity. Meanwhile, the world economy sees demand and growth drifting closer to the worst-case scenario: stagflation, in which there is no growth and high inflation.

But for Western central banks it’s another example of the futility of using monetary policy to counter the inflationary impact of a rise in oil and energy prices.

Fiscal policy (tax) could help make sure the burden was shared. Australia could follow the likes of India, the United Kingdom and much of Europe by imposing temporary windfall taxes on energy revenues and earnings.