The Politisation of the RBA – Labor or the Coalition?

Thankfully Paul Howes, National Secretary of the Australian Workers Union and Garry Weaven, Chair of Industry Funds Management, have zero influence on economic policy.  Last week, both made some absurd points and claims regarding monetary policy, the inflation target, the Australian dollar and operations of the RBA.

Both Howes and Weaven revealed the shallowness of their experience by showing little or no understanding of the critical importance of the inflation target.  It is imperative that the inflation target remains in place because on-going low inflation is the best thing policy makers can deliver if there is to be a boost to competitiveness, productivity and with those, employment and real wages.

There is also zero chance that the RBA charter is going to change, at least under this government, nor will the inflation target change, nor will there be any material changes to how the RBA works.

Howes’ and Weaven’s comments deserve criticism, as do others who say and write misguided, factually flawed or faulty economic analysis.  The economy is too important for ill-informed commentary and mis-guided policy prescriptions.

Which brings us to the point made by an ignorant and sometimes politically biased few that the RBA now is somehow being politicised, losing its independence or being lent upon by the Government.

That clearly is a fantasy.

If it were true, the only way it would show up would be in the RBA having inappropriate monetary policy settings and not achieving its inflation target.  There is no other way to even vaguely support the claim of political interference or undue influence.

Is there any other way any such politicisation of the RBA Board would show up?

Clearly not and only poor quality, inexperienced and/or biased commentators trying to get some attention would suggest that the RBA is structurally flawed due to any government decision or appointment.

Let’s turn this around and look at some facts to see whether there ever has been any political influence on the RBA.

Before starting, let’s agree with the unanimous assessment that a series of monetary policy changes starting today will not have a material impact on inflation for a year or two.   There is no debate about the long lags between interest rate changes and the impact on the economy.

Consider the only bad miss of the RBA in terms of its 2 to 3% target for inflation.

That error of the RBA showed up in the period from the end of 2007 to the end of 2009 when the underlying inflation rate averaged a shocking 4.0% having hit a peak of 5.0% in the September quarter 2008.

That monetary policy error had its seeds sown during 2005 and was really compounded during 2006 and early 2007 when policy was too loose for too long.  It must have been – there is no other explanation for such a bad miss on inflation.

Recall that in 2005, with mortgage rates some 50 basis points lower where they are today, the RBA delivered just one, piddling 25 basis point rate hike having left interest rates steady at very accommodative settings right through 2004.  In 2006, the year started with monetary policy still accommodative and despite the massive upswing in the terms of trade and sharp falls in unemployment, the RBA dragged the chain with just 3 hikes in the year.  Only at the very end of 2006 did the mortgage rate reach neutral; that is, roughly where it is today.   Clearly, the RBA delivered easy monetary policy for a very long 3 year period.

It is unlikely that there was any direct political interference on the RBA over that time, but curiously, it was the Liberal Party appointed Board of the RBA, including Governor Ian Macfarlane, that so badly blew the inflation target.   Monetary policy was kept too easy in the period from 2005 to 2007, curiously when the Liberal Party was in office and when Prime Minister Howard and Treasurer Costello used monetary policy and interest rates in its campaigning and economic rhetoric in a way the current government is still a million miles from approaching.

By the end of 2002, every member of the RBA Board with the exception of Frank Lowy, had been a Liberal Party appointment.  Mr Lowy’s term ended in December 2005 meaning that during 2006 and up to the election in 2007, every RBA Board member was a Liberal Party appointee.

It was only when Glenn Stevens became Governor, in September 2006, that monetary policy moved towards an appropriately tight setting.  While Glenn Stevens was appointed by the Coalition, there were no other contenders for the role when Ian Macfarlane retired.  To appoint anyone else would have been truly shocking.

Mr Stevens quite forcefully delivered 5 interest rates hikes in his first 16 RBA Board meetings as Governor, including 2 in early 2008 when the financial crisis was rapidly unfolding.  Finally, the RBA was acting to reign in inflation with a hugely hawkish approach.  And to the credit of Glenn Stevens and the RBA, that policy approached worked with inflation back on target by the middle of 2010.

The underlying inflation rate has been 2.75% or less since the middle of 2010 and it will be probably be close to, or at a 12 year low below 2.5%, when the March quarter CPI is released on Tuesday 24 April.  Unemployment has also recently edged up, fiscal policy is been tight, the world economy weak, yet the “politicised” RBA has rates at the upper end of neutral and shocked the market in the early months of 2012 by not cutting interest rates.   This is despite only 3 of the 6 outside Board members being appointed by the Labor Party.

And just getting back to the key point in this – if the RBA was being politicised, it would show up in monetary policy being too loose for too long and inflation building to a level above the target.  The exact opposite is happening right now.

In the last 20 years, there has only been one example where monetary policy has been too easy for too long and that was in the period from 2005 to 2007 when every member of the RBA Board has been appointed by the incumbent government.  Look at these facts and make up your own mind about the issue of politicising the RBA and monetary policy.

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The Terms of Trade Tumble – Interest Rates Need to Follow

The export and import price data for the March quarter confirm what the RBA has been saying for some time – the terms of trade are falling.

From what is now clearly a peak in the September quarter 2011, the terms of trade have dropped by 9.5% in the two quarters since.  To be sure, the terms of trade are still historically high, but a 10% downturn in a soft global environment is nothing to be sneezed at.

One of the more interesting parts of the recent market trends in that the Australian dollar has actually risen by around 1% while the terms of trade have fallen 10%. 

And before the cherry pickers query this fact, and probably cite the fall of the AUD from 1.10 to 1.03, please note that the average level for the trade weighted index of the Australian dollar was 75.8 points in the September quarter and yesterday, it was 76.7 points.  Some of the AUD fall in recent weeks have been against a stronger USD meaning the AUD is still buoyant on the cross rates.  And that’s what counts when it comes to export competitiveness or the lack thereof.

The RBA has, in recent months, noted the gap emerging between the terms of trade and the AUD.  Today’s  confirmation of that with the terms of trade data will only reinforce that view.

One reason why the gap has opened is unambiguously the interest rate structure that has prevailed for the last four months as the RBA has refused to lower official interest rates.  The AUD looks like a bubble that is getting a little bit of extra inflation from the RBA policy stance, but that can and will change in the months ahead.

The terms of trade data today will add a little more spice to the RBA Board discussion on 1 May on whether the cut should be 25 or 50 basis points.

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Gillard, Interest Rates, the RBA and the Liberal Party

Here we go again.  Today has seen some narrow and biased analysis of economic policy and political imperatives concerning the Prime Minister Julia Gillard’s comments on the economy, interest rates and the Budget.

Gillard’s words boil down to the point that having tight fiscal settings in a climate of on-going unbalanced economic growth will allow for easier monetary settings which in turn will stem the rise of the Australian dollar.  It’s actually the best policy mix when a country has a terms of trade shock which leads to excessive currency strength and risks exacerbating internal imbalances within the economy.

Before Gillard uttered a word on the issue, people like tin-man Christopher Joye, executive director and strategic advisor to Yellow Brick Road Funds Management and Rismark International, continued to push his empty barrow of the politicisation of the RBA.

I don’t think Chris actually read the speech or reporting of it with an opening comment that:

  • “The Prime Minister has broken with historical convention–for an incumbent government–and called on the RBA to lower interest rates

Well Chris, the Prime Minister neither said nor implied anything of the sort.  Here is what she did say at various times during the speech:

  • The RBA has “plenty of room to move further if need be”.
  • “we can give the Reserve Bank room to move on monetary policy if it chooses to
  • “In the current economic environment, should the RBA consider it appropriate to change the cash rate [it can move]”

Any observer can see that all that PM Gillard and the government is seeking is a shift in the balance of economic policy towards tighter fiscal policy and easier monetary policy.  And PM Gillard has made it crystal clear that the independent RBA may choose, if need be and if it considers it appropriate, to ease monetary policy some time down the track.

There’s nothing more than that.

Chris Joye obviously doesn’t remember or choses not to remember that during the 2004 election campaign, a Liberal Party advertisement mentioned:

  • “Under Labor, you may need to find an extra $962.23 every month just to keep your home.”  *

*  Source: Reserve Bank of Australia

Despite the obvious absurdity of this claim, and recall that the 2004 campaign was the election when Mr Howard claimed that “interest rates will always be lower under the Liberal Party”, the Reserve Bank under the Costello-appointed Governor Ian Macfarlane kept quiet on the issue, even though the Australian Electoral Commission has raised it with them.

Had the RBA and Ian Macfarlane come out and shown the claim to be a complete mistruth, it may well have altered the momentum in the election campaign.  It chose not to.

The RBA did, nonetheless, write to a W Meeham, the Liberal Party person on the advertising material, on 28 September 2004, saying:

  • We [the RBA] are most concerned that this could give the impression that the RBA has endorsed the brochure, when in fact is has not.  This view is reinforced by the fact that members of the public have contacted the Bank seeking explanation of the claims in the brochure.  Please ensure that no further distribution of the brochure occurs.”

The link to that letter is here:


Quite interestingly, RBA Governor Ian Macfarlane refused to make this comment public before the election even though the RBA has been in contact with the Australian Electoral Commission and interest rates were a dominant election issue.

The issue only came to light after an FOI investigation.

The RBA Press Release of 8 April 2005 outlining the issue is also copied below.

Media Release

Number 2005-05
Date 8 April 2005
Embargo For Immediate Release

Correspondence Between Reserve Bank and Australian Electoral Commission

During last year’s election the Reserve Bank passed on a complaint from a member of the public to the Australian Electoral Commission (AEC) about a leaflet distributed in an electorate in southern Sydney and authorised by a Mr W. Meehan. Following the advice received from the AEC, the Bank notified Mr Meehan. The Bank did not raise the matter with the Government or the Federal Liberal Party.


Mr David Emanuel

Reserve Bank of Australia


Phone: +61 2 9551 9700

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Back to 1918 for Abbott, Hockey and Robb

The senior members of the Opposition in Australia, namely Leader Tony Abbott, Shadow Treasurer Joe Hockey and Finance Spokesperson Andrew Robb frequently froth at the mouth with rabid delirium each time the issue of government debt is discussed.

For the record, the current estimates show that that net government debt will peak at just under 9% of GDP this year and as the Budget returns to surplus, it will start to fall.

Every economically literate person and many others know full well that this level of government debt is very low when set against any international or historical benchmark.

Which lead me to look at the Niall Ferguson data base which has more than 200 years of historical data on government debt in the United States.

I went back in the data base to see the last time that the US had net Federal government debt equal to 9% of GDP.

It took a while, but finally I found out that the last time the US Government debt to GDP ratio was 9% was in 1918.

And it seems that since then, the US economy has done pretty well, even though 94 straight years and counting, the government next debt to GDP ratio was more than 9%.

I wonder what Abbott, Hockey and Robb think of that?

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So what Inflation rate is needed for the RBA to cut 50?

Just about all the market commentary around now agrees that if the March quarter underlying inflation rate comes in at 0.8% or less, the RBA will cut rates by 25 basis points on 1 May.  It is difficult to argue with the broad theme of that judgment.

One question that I haven’t seen discussed is what sort of underlying CPI result would compel the RBA to cut 50 basis points on 1 May?

If the underlying inflation rate comes in at 0.5% as quite a few markets people are forecasting, the annual rate of inflation will fall to a 12 year low of 2.3%.  To me, this would be enough for the RBA to cut 50 basis point given the current level of mortgage rates, but what if we get a further downside surprise?  Say underlying inflation comes in at 0.4% with the annual rate dropping to 2.2%?  This would be stunningly low in itself and with a high 0.8% June quarter 2011 CPI dropping out of the run rate next quarter, underlying inflation could fall to a record low in three months time.

Surely this would be enough to get the RBA to cut 50?

The markets people seem to only be arguing about what inflation rate is needed for the RBA to cut or not.  This is too narrow given the performance of the economy more generally.  An additional question should be how low will the CPI need to be for it to cut 50 basis points.

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Inflation Poised to Fall to a 12 year Low

The March quarter consumer price index will be released on 24 April.  There is a good chance that the annual underlying inflation rate will fall to a 12 year low.

According to the data from the monthly TD-MI Monthly Inflation Gauge, it is pretty clear that underlying inflation for the March quarter will be contained.  My guess, based on those data, is for the underlying CPI to rise 0.6% for the quarter.  A few market forecasts that I have seen are for a rise of 0.5 or 0.6%, so I suspect everyone else is looking at the Inflation Gauge result in coming up with these forecasts.

If the underlying inflation rate comes in at 0.5% and of course there are no revisions to the recent data, the annual rise will drop to 2.3% – the lowest annual result since the December quarter 2000.   And this 2.3% includes (obviously) a 0.8% quarterly rise from the June quarter 2011, with that result dropping out of the annual run rate next time meaning there is a strong chance that annual inflation will fall yet further by the June quarter.

Looked at another way, the annualized rate for underlying inflation for the last 3 quarters will be around 2.0% – clearly very low and no surprise given the prolonged period of sub-trend economic growth and well contained wages pressures.

A year ago, in the May 2011 Statement on Monetary Policy, the RBA was forecasting underlying inflation to be 3% in the year to June 2012.  As is clear now, this is wrong.

With inflation missing the RBA’s own forecasts by 75 basis points and possibly more, the RBA has been slow to cut interest rates.  There have been only 50 basis points of easing in the official rate in that time with mortgage rates down less than 40 basis points.  The scope, very clearly, is for more cuts to be delivered, if for no other reason that keeping real rates steady. 

But frankly with the economy in muddle mode, monetary policy needs to become accommodative to ensure inflation does not become too low.

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Cherry Picking the RBA Minutes

Below are some cherry-picked comments from the RBA Board Minutes for April released this morning.

Make up your own mind whether the RBA should have cut rates from current levels or not.

The growth rate of the world economy was expected to be at a below-trend pace in 2012, with ongoing weakness in Europe and an easing in the pace of growth in China.

The financial problems in Europe continued to be a potential source of adverse shocks to the world economy, despite downside risks to near-term global growth having receded somewhat over the past month.

Growth in the Chinese economy had clearly slowed over the past six months in response to a policy-induced softening in domestic demand and weaker external demand.

After peaking in the September quarter, Australia’s terms of trade fell by almost 5 per cent in the December quarter 2011, owing to declines in bulk commodity prices. Since the start of 2012, spot prices for coal had fallen by 6–7½ per cent, but iron ore prices had increased by around 10 per cent

To the extent that higher oil prices reflected concerns about supply, they were adding to the downside risks to the global recovery and upside risks to headline inflation.

Members noted that the national accounts for the December quarter had shown an increase in real GDP of 0.4 per cent in the quarter and 2.3 per cent over the year, which were both lower than expected.

Growth in exports over 2011 had been weaker than expected, mainly because of lower coal exports… Service exports had also been weak, reflecting a decline in the number of visas for foreign students as well as the effects of the higher exchange rate and lower external demand.

Recent indicators show that consumer sentiment fell in March to be a little below its average level, with household concerns regarding future unemployment at their highest level since mid 2009.\

The level of non-mining investment had been flat over 2011, and recent surveys of business intentions suggested that non-mining investment was likely to remain sluggish for some time. Business credit growth had increased slightly over recent months, but remained low.

Labour market conditions remained subdued, with employment falling by 15,000 in February and showing little change for much of the preceding year; increases in employment in mining, health and public administration had broadly offset declines in employment in manufacturing, retail trade and accommodation & food services.

Members noted that an easing in average hours worked and a decline in the participation rate were indicative of a softer labour market than that implied by the unemployment rate.

Recent business surveys and liaison indicated that firms expected wages to continue to grow at around, or a little slower than, their recent pace.

The Australian dollar had depreciated over the past month, but still remained at a high level. The recent depreciation, in part, reflected increased concerns among market participants about the effects of the moderation in Chinese growth on the Australian economy.

Members noted that recent information on the world economy was consistent with growth at a below-trend pace in 2012 and slower than in 2011.

For the domestic economy, members observed that the balance of recent data suggested that output growth was somewhat below trend over 2011.

They noted … soft overall conditions in the housing sector and the likelihood of significant fiscal tightening in the next few years.

Despite the rate of unemployment showing little change for some time, it was apparent that labour market conditions had softened over the course of 2011.

Over the past month, domestic financial conditions had been mostly unchanged, with interest rates for borrowers remaining close to their medium-term averages, credit growth modest and the exchange rate remaining high in the context of an easing in the terms of trade.

The Board had eased monetary policy late in 2011. Since then members had lowered their assessment of the pace of growth somewhat.

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Me in the AFR today: Fiscal prudence is right policy for now

There is an almost unlimited demand on government finances. Be it a dental scheme, disability insurance, aged care, a literary award or infrastructure, a case can be made for government funding and intervention. Many demands for government funds are driven by micro-economic imperatives aimed at lifting productivity; others go to common decency and fairness for a very rich country like Australia. Others are political largesse and these are the kind that need to be not only rejected, but abolished.

The harsh reality of governing is that there is a limited supply of funds. This point is all the more problematic when constituents shy away from having to pay tax, or indeed the government tax take is running near historical lows due to prior discretionary tax cuts and a cyclical downswing in revenue as the result of a sustained period of below trend economic growth.

For the full article, click here:


I hope Greens leader Christine Milne can understand how irresponsible and misguided her comments on the budget are.

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Mortgage Interest Rates and Unemployment – Why the RBA Can Cut 50 in May

A few excitable, inexperienced and unimaginative people judged the labour force data last week as a reason why the RBA would/should be cautious about cutting interest rates.  Recall employment rose by 44,000 and the unemployment rate was steady at 5.2%.

It might be useful to look at RBA policy settings against the unemployment rate over the past decade to see how far behind the curve the RBA risks getting if it doesn’t cut 50 basis points in May and probably more beyond that.  The RBA seems to have been wimpish in holding off rate cuts so far in 2012 and here is why.

Let’s go back to the period around 2004 to 2006 to look at why interest rates should be 50 to 75 or even 100 basis points lower than they are now and how a sub-7% mortgage rate is prudent and entirely consist with the recent labour force data.

Before we start, I note the current standard mortgage interest rate is around 7.4% and that over the past year or so, the unemployment rate has generally edged up from around 5.0% to around 5.25%.  Fact.

But what happened in 2004?

During that year, the unemployment rate drifted lower – from around 5.5% at the start of the year to around 5.25% by the end, yet mortgage interest rates were unchanged at 6.75% … right through the year.  The RBA did not adjust monetary policy at all in 2004.

During 2005, the unemployment rate was again steady to slightly lower.  It drifted from around 5.25% to around 5.0% by year end -  a nice result but hardly a rapid move to an overheated labour market.  In March of 2005, the RBA delivered the only rate rise for the year with a single 25 basis point rate rise.  It cited “higher employment costs” as a reason for the hike.  Mortgage rates edged up to around 6.95%.

See the pattern?  Over a two year period where the unemployment had very slowly, but very assuredly edged down from 5.5% to 5.0%, mortgage interest rates were around 6.75 to 6.95%.

I would also note that over these two years, fiscal policy was also generally stoking the fire with real government spending rising 3.9% in 2003-04; 3.5% in 2004-05 and a tub thumping 4.6% in 2005-06.  That’s 12.5% real growth in government spending in 3 years.  Due to a record tax to GDP ratio, there was a 0.7% of GDP rise in the underlying cash Budget balance over that 3 year period.

Only in 2006, as the unemployment rate fell well below 5.0% and actually ended the year around 4.5% did the mortgage rate rise substantially, – it reached 7.6% by the end of 2006.

Which brings us to now.

As mentioned, unemployment rate has inched up to around 5.25% having been a touch below 5.0% a year or so ago.  Aided by RBA monetary policy decisions, but hurt by wholesale funding conditions, mortgage rates have only fallen a bit and are now around 7.4% – as you can plainly see, a rate 50 to 75 basis points higher than when the unemployment rate was at similar levels and falling 6 or 7 years ago.

I note that in terms of fiscal policy in this cycle, real government spending fell 0.4% in 2010-11, will rise 3.7% in 2011-12 but will fall by a near record 3.0% in 2012-13.  This is a total rise of around 0.2% in government spending in 3 years.  The Budget balance will contract by a record 4.3% of GDP in those 3 years.

So there we have the contrast:  The last time the unemployment rate was in the low 5s, mortgage interest rates were some 50 to 60 to 70 basis points lower than where they are now, and that was with public demand adding to inflation risks.

We now have unemployment in the low 5s, fiscal policy is tighter than a bass drum yet the mortgage interest rate is 7.4%.

The bottom line is that the RBA has oodles of scope to be cutting interest rates and only in recent times has the Bank realised this.  It knows it has to catch up – it knows banking funding cost pressures mean they will have to cut official rates harder to achieve the same impact on mortgage interest rates by way of example. It also knows that overall activity is still on the soft side.

So get set for a 50 basis point cut in official interest rates in May.  Such a move is essential if the RBA is to catch up to where rates should be – that is, with mortgage rates at 7.0% or a little less.  

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Labor Versus Coalition on Interest Rates

In February, I posted this article on interest rates http://alturl.com/ffkob which showed official interest rates and mortgage rates under the Coalition Government from 1996 to 2007 and the Labor Government from December 2007 to now.

I’ll repeat the key themes from that earlier article for context:

When should a new government take responsibility for current economic conditions?   Or rather, when does the implementation of new policies have a meaningful influence on the economy, inflation and even interest rates?

The issue arises with comparisons about interest rates under the current Labor Government (election day 24 November 2007 and sworn in on 3 December 2007) and the Howard Government (election day 2 March 1996 and sworn in 11 March 1996).

Should the economic management of this Labor Government be marked the instant it won – from December 2007 to now – or from some other date?   So too for the Howard Government and its election victory in March 1996.

The easiest and cleanest way to make comparisons is to have it ring-fenced the month the new government is sworn in and then “sworn out”.  But this is clearly erroneous given that policy adjustments could not and would not be effective for some months after the Government is formed.

The Labor Government’s influence on employment, for example, should not start from December 2007.  Nor should its influence – to the extent this is a factor – on interest rates be judged from December 2007.  So too the Howard government start and end dates.

The more difficult question is when do you start?

Is 3 months too early?  Probably.  6 months?  Maybe there are some clear influences coming through.  12 months?  Maybe too.  In a year a new government will have delivered a Budget, there is a year of policy delivery and an influence on the business and household sector as the new governments issues are digested, debated and implemented.

Obviously, the level of interest rates has many parents of which broad government policy settings are just one.  Indeed, global events, the terms of trade, housing bubbles and busts, wage momentum, the unemployment rate and about 247 other factors all have some influence on the RBA and its decision on setting interest rates. 

Whatever these influences, I have prepared an interest rate comparison on several grounds.  I think it makes interesting reading.  Using the swearing in dates as a benchmark, it is clear that the cash rate is a little lower under Labor, while the mortgage rate has been a little lower under the Howard Government.


With two months more data, I have updated these tables – the impact on the bottom line is small.


Official Cash Rate

Standard Mortgage Rate

Howard Govt (Mar 96 to Nov 07)



Rudd/Gillard (Dec 07 to now)



If we work on the assumption that the government cannot claim to be responsible for interest rates until they have had 6 months to change the economic landscape, the next table shows how the averages look with that 6 month lag.  The cash rate is markedly lower under Labor but mortgage rates are line ball.


Official Cash Rate

Standard Mortgage Rate

Howard Govt (Sep 96 to May 08)



Rudd/Gillard (Jun 08 to now)



Let’s look at the issue with a 12 month lag:


Official Cash Rate

Standard Mortgage Rate

Howard Govt (Mar 97 to Nov 08)



Rudd/Gillard (Dec 08 to now)



I concluded two months ago that: 

“Which ever way you cut the record of interest rates under the Howard government, the cash and mortgage interest rates are basically the same – cash a tick below 5.5% and the mortgage rate 7.25%.  Moving further away from the legacy of the Keating Government makes no difference to these averages.

For the Labor government, there is a difference as you get further away from the hangover of the Howard Government spending spree and reckless cash handouts. That difference is a markedly lower average cash and a moderately lower mortgage rate.

To be fair, another year or two is needed to have a better (bigger) sample size for the current government.  Let’s see how it looks in a years time.”

I’ll stick to that and revisit the issue a little later.

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