It appears the Reserve Bank will up interest rates in a couple of weeks out of concern that inflation is becoming too high. One of the statements from the Prime Minister is that the core inflation is still between two and three percent. The problem with core inflation is that it is an inflation reading with all the stuff that is inflating taken out. Also known as inflation ex-inflation.

Barry Ritholz has an interesting post on the history of core inflation as a metric. It comes from the US Federal Reserve in the 1970s when America was facing heavy inflation pressures. The Chairman of the Federal Reserve asked for inflation with the volatile energy figures taken out of the CPI. Then as each differing part of the economy went into wild inflation they removed those from the CPI too. Quote of a Quote:

As a result, the Fed failed to spot the breadth of emerging inflationary pressures throughout the economy. It looks unlikely to make the same mistake this time . . . Prices took off in the 1970s largely because of serious policy errors. Policymakers now understand that rising inflation harms growth, and independent central banks are more likely to stamp on inflation swiftly

Statistical Process Control Engineers use exponential weighting on their time series charts when their system is out of control or on the point of going out of control. It dampens the volatile readings and brings them into some kind of order for the eye. Core inflation is a similar device. Because the inflationary components of the CPI are being stripped out of the number it will mostly give a figure lower than the CPI.

It was New Zealand in the 1980s that pioneered a policy of focusing on inflation first and foremost in monetary policy. Nearly all independent reserve banks follow those policies now.

Global dynamics have placed Australia in a curious economic position. If it was not for the China Effect we would have had much more serious inflation issues before now. This is not just true of Australia, but the US, Europe and any other nation that imports Chinese manufactures.

The other curiosity is when Japan's economy went deflationary they set their interest rates to 0%. It was only in July last year that Japan raised their interest rate to 0.25%. This has meant the world has been awash in cheap Japanese money to finance all manner of growth including housing speculation.

Chinese goods are only going to get more expensive as the labor force becomes more specialised and experienced. Japan wont be in a deflationary funk forever so cheap interest rates won't be permanent.

However, nearly every other aspect of economic life has been inflating heavily; energy, housing, food, education and health. In the US they have all been in double if not triple digits over the last decade - outstripping the CPI handily. Australia has been no different though education and health is partially hidden to the consumer in Australia, but not the Treasury which has noticed the inflation in those sectors and isn't happy about paying for it.

The institution of an independent Reserve Bank is an excellent one. It is also good that the Howard Government is not interfering with it politically in order to get political outcomes. A temptation they have not been able to stay away from in other executive departments. I don't see any cause for concern (IANAE), the oddities of an awakening China and a delfationary Japan won't exist forever, and the Reserve Bank is good hands to have monetary controls in.

Barry Ritholtz argues that the US Reserve Bank is the only one that makes interest rate movements based on core inflation. This is an inflation reading without all the inflationary bits in it and can be traced back to President Carter's time. Inflationary stuff like energy costs and food are removed from it. Ritholtz considers this indefensible. As to the recent increase in interest rates in Australia:

Unlike the spendthrifts here in the US, other Central Bankers around the world understand what the true definition of inflation is. Consider the following: The Reserve Bank of Australia hiked rates to an 11 year high (due to inflation concerns). And, Miller Tabak's Peter Boockvaar points out that, over the past month, Iceland, Romania and Mexico have raised interest. While the RBA move was expected, the Australian $ rallied to a 23 1/2 yr high vs the US$.

The US bailing out of speculation by lowering interest rates and making money cheap was known as the Greenspan put, it is now getting known as the Bernanke put too. Ritholtz believes that this policy goes against the Reserve Bank's mandate for price stability. Consequently the US Reserve is directly contributing to inflation and a weak US dollar.