Henry,

You may right about the RBA needing to make a pre-emptive rate rise of 50 basis points (though it may have missed its chance). However, the main problem is that the economic response to interest rate increases is not elastic.

As rates increases, businesses do not slow down manufacturling/production/investment/planning/purchasing etc etc. Large projects will still go ahead - a rate increase from 5% to 5.5% will not effect a billion dollar project, for example. But at some point, at some interest rate figure, all bets are off.

Given that most businesses operate within the same economic and environmental constraints, I believe that this cut-off point is at much the same level for most businesses. That is why we do not see much of a slowing on the business side of things as rates climb from 5 to 6 to 7 percent (although it does effect households, particularly with regards to consumption). But when we get to that cut-off point, at which all projects/investments are no longer feasible, is when we start to see a real decline in economic activity.

Picture it as a tap - it's either on and flowing or off and stopped flowing - a tap that you can't half-close in order to regulate the flow.

Ah you say, what about the rising costs of the debt that businesses are carrying, surely as rates rise the cost of that debt rises too? Thus leaving less cashflow for other economic activities? Yes that is right, but it only applies if businesses are carrying large debt levels, which we all know just isn't the case.

Bottom line: a 50 basis point rise now may just take us over that point of no return.

This article suffers from jargon-inflation, and so it must be very important and a deeply meaningful writing experience. Try writing in simple English, then both the author and the reader might understand what is being said. The feline quadruped proceeded to recline itself to repose on the floor-covering substance, or the cat sat on the mat. Take your pick.Three different types of inflation-WOW! Do we have a solid solution series between them as well? Are they end-members in a triangular diagram?

Not being an economist I see some fundamental problems.
1) We mine copper, sell it to China and buy it back as bath taps and pipe and wire, etc. Which means money leaves Australia.This is surely inflationary.
2) The price of oil will continue to rise, which is inflationary.
3) The mining boom has distorted our economy, with skilled folk leaving other jobs to go mining at high salaries. Inflationary.
4) The shonky-loan housing-debt scam in the USA has got the stockmarkets and banks s@#$$%^g themselves, especailly those who have bought these scam debts to make money out of them. So no lending, no investment money running around to keep things moving.Jobs get lost Recession. No spending. More jobs get lost. More recession.

How do the RBA interest rate rises stop this? Rather they screw us, as they give us less money to keep the wheels of industry turning. They will lead to foreclosures in Australia and falling house prices, which in turn will futher deepen the scam-debt problem. Which will frighten investors and banks more and push up the price of money yet more. Inflationary. And also push up the price of gold (inflationary). Which leads us to the 1930s and the Great Depression, which was only alleviated by Keynesian SPENDING by government. Is there a lesson in history for us?

I like to think of interest rates as akin to tugging on my arm to move my leg - it may work but you can expect other parts of my body to be jumping around as a consequence.

Though, what is the solution? if there was some other tool to combat inflation the RBA would no doubt be using it already...

Let's face it - inflation in many cases (particularly Australia's at the moment) is simply the side-effect of a growing and healthy economy, which eventually hits its constraints, leading to inflation. The only solution under this scenario is to slow growth, by using rate rises.

The Reserve Bank has very few tools with which to direct the economy, raising interest rates is one of these tools. My economics is a little rusty but the level of inflation that is acceptable may be 2% or 4% or even 7%, its probably subject to fashion - just like hemlines.

Henry said that Australia is importing its inflation from China and from the United States - so can the Reserve Bank really effect inflation?

Reduce consumer demand by reducing migration - at the moment we have 350,000 people migrating to Australia per year. The migrants all want jobs, houses, schools for their kids, food, consumer goods from China

The relationship between interest rates and inflation is generally understood by economists is it? If so, then they should pass this insight to the US Federal Reserve, who are continually cutting rates.
Is it at all possible that our great, powerful and rich friends in the US are deliberately lowering the value of the dollar to inflate their way out of their enormous foreign debt, and dudding all those nations who have large $US reserves?

HenryVIII and Countryboy,

Our current economic problem is obvious, and yet is not acknowledged by politicians or the political establishment.

The problem is that we are living far above our means, and there needs to be a considerable reduction in our standard of living, particularly of ordinary people. This is manifested by our foreign debt, which has now reached $600 billion, and our annual balance of payments deficit, which has reached $80 billion p/a.

The villain in the piece is keynesian economics, which is so far tilted against the saver, and in favour of the borrower, that the net result, after 60 years, is $600 billion of foreign debt. When this is called in, which has happened twice before, in 1893 and in 1931, things won't be much fun for anyone.

The problem, of course, is that when people borrow from the banks, the banks promptly borrow most of it from overseas, as there are not enough idiots here who save money. When the banks are unable to refinance their foreign borrowings, they will be unable to turn to the Reserve Bank for help, as it cannot lend them foreign exchange. As a result, the banks will simply have to raise the interest rate they offer on foreign borrowings to whatever rate is necessary to secure the loan - or go bankrupt. When the NZ foreign debt was called in in 1984, rates went to 27%.

What does it take for people to realise that for a continued stable society:

1. People must save up for something before buying it. If you don't have the cash, you go without.

2. In a world of sovereign states, it is dangerous for a country to have a large foreign debt (or credit).

3. The old virtues of fiscal responsibility were not learned for nothing. A generation that ignores them will do so to its detriment.

The fraudulent system of keynesian spending and borrowing may be coming to an end. With luck, when the Chinese dominate the world financial system, they will bring back an honest world system, such as the Gold Standard.