EXTRACT OF THE ADDRESS TO THE

ECONOMIC SOCIETY FORCASTING CONFERENCE LUNCH

PARK HYATT, MELBOURNE

THURSDAY, 19 AUGUST 1999

1.10PM

SUBJECT: CPI

When the last CPI figures came out I made the comment, that there was no life in the inflation dragon. I did not say that the inflation dragon was dead – there was no life in the inflation dragon. I don’t think the dragon of inflation will ever be dead. The dragon will sleep from time to time and he’ll be dormant over long periods. But we shouldn’t convince ourselves that this is now an extinct dragon. It’s a dragon that we always had to keep half an eye cocked on.

Now there will be a very favourable economic environment for the implementation of the Government’s new tax system.

Economic growth may well have moderated from the exceptionally high near 5 per cent, which it is at present. We’ll have an improving international economy in 2000-2001, strong productivity as I’ve shown, healthy company profitability and moderate wage increases. And inflation is expected to remain in check right up to the introduction of the GST.

The RBA said in its semi-annual statement yesterday and as the Budget forecasts also say, inflation is forecast to be a little over 2 per cent in the first half of the year 2000 – near the bottom of the 2 to 3 per cent inflation range.

It’s a situation that’s been brought about by prudent monetary and fiscal settings. And by encouraging competition in the Australian economy, competition should put a downward pressure on prices.

We are already seeing the impacts of the first changes to the tax system. At this point the impact is lowering prices. The 32 per cent wholesale sales tax rate on the 29^th of July will reduce to 22 per cent. That is reducing the costs of most electronic goods. And this will translate into a lower CPI in the September quarter than would have been the case, all other things being equal.

Conversely, on 1 July 2000, when WST is abolished, some stamp duties are abolished, and fuel costs fall for business, and a GST is introduced, you would expect a price increase in the lead up to the September quarter 2000. The immediate price impact will thereafter abate, with reductions in business tax costs as the current embedded wholesale sales taxes in the production chain are eliminated and new arrangements to reduce diesel and state reduced taxes begin to feed through the system.

So what will be the overall impact of all of this on the CPI? Well this, of course, depends on two factors. One is the underlying rate of inflation, all other things being equal. And secondly the impact of the new tax system. In the RBA Bulletin released yesterday, in a survey of financial market economists, the CPI effect, excluding the tax package, was found to be a median of 2.2 per cent in the year to the June quarter 2001. As regard to the impact of the tax package on prices, on average economists in the survey were expecting a first year effect of around 2 per cent. The combined result according to financial market economists would take the forecast CPI for the year to the June quarter 2001 to a little over four.

Now the Government issues forecasts twice a year, in the Budget and in the Mid Year Review – which will be released probably in November of this year.

In assessing the effect of the GST package we must take into account two factors.

The first is that the direct effect of the GST in mid-2000 will be partly offset by other parts of the package, such as the abolition of wholesale sales tax, diesel tax changes, the abolition of state taxes. Whilst most of the effects of the GST will be upfront, some of the offsetting tax abolitions will take time to flow through fully. And the benefits of reduced costs to business from the removal of embedded taxes in production costs will not be immediate, but will take some months to flow through. Some effects such as the introduction of input tax credit, the staged transition in relation to motor vehicles, the abolition of financial institutions duties and bank accounts debits tax will take several years to flow through. So the initial effects of the GST on price will be higher than the longer run effects.

Secondly, it needs to be clearly recognised that the implementation of the package may result in first round increases in the level of prices, but there are likely to be few, if any, second round effects that would result in the package feeding into inflation in an ongoing manner. The extent of any second round effects will, of course, be dependent on the degree of competition in a given market place as well as the extent to which there are wage claims that seek to compensate more price increases.

The best way to ensure that there is no profiteering in the implementation phase is by heightening competition. In a competitive market price takers will be punished by competition. In addition the Australian Competition and Consumer Commission has been charged with ensuring price rises faced by consumers are appropriate. It has fines of up to $10 million and it has already taken steps to ensure that consumers will be treated fairly.

In relation to wages, the Government has designed the package to include income tax cuts and other measures such as increased pensions and family allowances that will more than compensate consumers for the overall increase in prices. This is the point that I’ve made on many occasions. There is no basis for wage claims on the basis of price effects. Take home salaries will be increased as a result of income tax cuts, and family allowance increases to more than compensate for any price effect.

In yesterday’s statement the Reserve Bank made it clear that in assessing the appropriate stance of monetary policy, it intends to abstract from the first round effects of the GST on price level and to thus focus on the ongoing rate of inflation. The Bank will, of course, be keeping the inflation situation under close scrutiny during this period.

As I have stated previously, we still expect economic growth to moderate somewhat in 1999/2000, followed by a gradual pick up in growth on an improving world economy in 2000/2001. Against this background the Bank anticipates that there will be relatively little in the way of second round GST effects and inflation will settle back to the 2 to 3 per cent target range within a year of the GST implementation. The critical thing is to keep an eye on the continuing rate of inflation and to look through the one-off effect of the new tax system. And the critical thing for employees and employers is to take into account the fact that income tax cuts, increases in family allowances, increases in pensions, have already been factored in to more than compensate for any price effect. To keep our eye on moderate wage growth, improving productivity, to continue growth with a low continuing inflation rate with the benefits of increased employment that that will bring.