The inflation menace is up and running.

Inflation is the world’s major menace, and it hasn’t gone away, just been asleep for a few years. Global inflation is back, and this will be the theme for some years, perhaps into the end of 2010, as central banks grapple with resurging inflationary pressures.

The problem is, they are not tackling inflation the way they should be.

There are two schools of thought on what a central banks job should actually be in setting monetary policy.

One is that central banks should go for growth (and other more nebulous targets) and try to kick start the collapsing growth in their economies by lowering interest rates.

This ignores the reality that Japan has had low to zero interest rates for 10 years, and sadly, no resulting growth.

Equally it ignores the fact that New Zealand has had the highest interest rates in the western world for a number of years and has had reasonable growth, only slowing this year as global growth tumbled on the back of the credit crisis.

So it is plain that the level of interest rates is not necessarily a driver of the level of growth in an economy. Growth is a function of many elements; the relative level of interest rates does not solely drive it.

Consumer confidence, wage rates, tax rates, government policies, property values, exchange rates, the level of productivity, these and many other factors all contribute to drive growth pressures. Central banks who ignore inflation and change interest rates to target growth do so at their peril.

Recent examples are the US, New Zealand and maybe, Australia.

The second school of thought, and my preference, is that central banks should solely focus on inflation and nothing else. The level of interest rates is set to control inflationary pressures, be they primary as in oil and food shocks, or secondary in transport cost increases and plastic prices increases, to name but a couple of obvious ones. In my view, the job of a central bank is to control inflation, even, if necessary, through a recession. (By the way, a recession does NOT necessarily mean no inflation).

Example: The European Central Bank: probably the best CB in the world.

The US has the excuse in being willful on inflation because of the sub prime disaster and their property meltdown, flowing into the credit crisis. The reality remains that banks lent money to people who could not repay it, over properties that were vastly over priced. It is not the role of a central bank to bail out bad lending decisions. With US inflation at close to 6% and US interest rates at 2%, they have negative real interest rates. This is madness. The price is higher inflation, with recent US data being the highest in 17 years and set to go higher yet.

Here in New Zealand, The Reserve Bank of New Zealand has no such excuse, and lowering interest rates when they are forecasting higher inflation is worse than madness, it is simply not doing their job.

Governor Alan Bollard is gambling that the slow down in the economy will compensate for the higher (one off) prices feeding through from (principally) higher food and oil prices. He is right to look through these one off impacts.

But he is wrong that secondary inflation pressures will not result. Every company I have spoken to is seeing price increases across the board. Bollard thinks they will not be passed on because of the pressures of falling sales.

I have news and its all bad for the Reserve Bank. Companies would rather sell less at a profit than more at a loss. Everyone is putting up prices to recover margin, and what is worse, people expect prices to go up, so inflationary expectations are rising quickly.

The very thing he is there to defend against is happening, inflationary expectations are rising, and once that rabbit is out of the hat, there is no catching it again without a huge amount of pain.

No growth and high inflation is the fear of any government but sadly, that is where we are headed again.