Writing in The Australian Financial Review, economics correspondent Jacob Greber begins his discussion of the Xenophon proposal for the RBA to dump its 2-3% inflation target with the assessment “What a stupid idea”. Given that he is dismissing proposals with wide support in the economics profession (including economists as different as me and Warwick McKibbin in the Australian context) one would expect that he had a knockdown argument to present. In fact, he offers a valid but minor nitpick and a string of confusions and errors.
The nitpick relates to the distinction between nominal GDP growth, as reported by the Australian Bureau of Statistics, and the way the term is commonly used in the context of monetary policy discussion, to refer to the sum of the inflation rate and the real rate of GDP growth. Inflation is typically measured by the Consumer Price Index. However, the statistical nominal GDP is associated with a different inflation measure — the GDP deflator — which is heavily influenced by export prices.
So, a policy that targeted the statistical measure would imply trying to reduce growth when export prices boomed, and increase growth when they fell. In most times and places, the difference is too trivial to matter, but in the context of the recent minerals boom in Australia, it was substantial. So, I’d suggest we really want to use the phrase “nominal growth targeting” with nominal growth spelt out as the sum of CPI inflation and real GDP growth.
After that valid point, we have a mess of confusions and contradictions. First, Greber objects to Xenophon’s proposal on the basis that it would push up housing prices. If this is to be taken seriously, it means that the RBA should be targeting asset prices as well as CPI inflation. While there’s a good case to be made here (I discussed the issues in a paper with Stephen Bell quite a while back) it contradicts the central claim that everything is fine with inflation rate targeting.
Making the contradictions even worse, Greber notes that inflation has been well below the target range for some time. That is, under an inflation-targeting system, the Reserve Bank should be cutting rates. But Greber appears to oppose this, while conceding that “To be fair, there is a legitimate debate to be had about how far and for how long inflation should range outside the current band”. In this context, the question of a shift to nominal growth targeting is a red herring. Real growth (about 2%) is only marginally below the likely long-term trend (2.5%), so a monetary policy that targeted both growth and inflation would, if anything, be a little less expansionary than a strict inflation target
The obvious problem being ducked here is that, if the RBA sticks to inflation-targeting, it may well have to cut interest rates all the way to zero, as most other central banks have already done. So, the temptation is to accept a long period when we are below the target rate. But that, in effect, is switching from a 2-3% target to a 0-3% target, something for which no real justification has been given.
Like Bernard Keane and Glenn Dyer, to whom I responded previously, Greber makes much of Australia’s special circumstances, treating nominal GDP-targeting as (to quote Keane and Dyer) “a foreign solution”. This piece of economic exceptionalism is surprising coming from a haven of orthodoxy like the AFR, and even more surprising in the context of monetary policy. Inflation-targeting, central bank contracts and 25-basis point interest rate adjustments aren’t Australian inventions. We adopted this approach at the same time as the rest of the world, and for the same reasons. We’ve had much better outcomes as Greber notes, but there’s nothing to suggest that inflation-targeting is the main reason.
On the contrary, inflation-targeting has evidently failed nearly everywhere in the developed world, in at least three ways:
- it has not kept inflation within the target range;
- interest rates have been driven to zero or below, so that “emergency measures” like reliance on open market operations now appear to be permanent fixtures; and
- it has not delivered on the promise that targeting inflation would also deliver stable GDP growth.
The first of these problems is already evident in Australia, and the second appears imminent. We should think twice before saying that, since nothing has gone badly wrong so far, we should stick with our existing policy framework.
Greg Jericho in The Guardian has some similar thoughts.
*This article was originally published at John Quiggin’s blog