Working Papers

Failing on Inflation? Then Shift the Goal Posts

With inflation in Australia running well above the 2-3% medium-term target range, the usual and even some not so usual suspects are starting to argue against an anti-inflationary monetary policy.  As Alan Wood notes, this argument transcends the usual partisan alignments:

On an unlikely unity ticket, failed prime ministerial aspirant John Hewson and the ACTU’s Sharan Burrow are calling for the RBA’s inflation target band to be widened - with a new ceiling of, say, 4 or 5 per cent…

A second siren song, sung this week by Opposition Treasury spokesman Malcolm Turnbull, is that “while there are inflationary pressures evident in our economy, many of them are beyond our control, such as higher oil and commodity prices”. The implication is that Australian monetary policy can do little about this.

In this context, it is worth pointing out that the RBA’s inflation target is already overly generous by international standards.  The ECB, BoE, BoC and RBNZ all have inflation targets with ceilings or mid-points of 2%.  The Fed has no formal target, but Federal Reserve officials have long stated a preference for inflation not to exceed 2%.  The 2.5% medium-term average that the RBA would deem a policy success would constitute a policy failure by the standards of comparable countries. 

The RBA’s 2-3% medium-term inflation target means that Australia’s policymakers have already institutionalised a higher rate of inflation than would be considered acceptable in comparable countries.  While short-run inflation outcomes are subject to external shocks, medium-term inflation outcomes are a matter of policy choice.

posted on 26 April 2008 by skirchner in Economics, Financial Markets

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What these people don’t seem to get is that the rationale for price stability is to avoid distorting resource allocation decisions. This means that if some elements of an inflation index rise - for whatever reason - others need to fall to maintain price stability. Whether or not crunching other sectors of the economy (eg retailing) is ‘fair’ or otherwise somehow warranted is besides the point.

Posted by .(JavaScript must be enabled to view this email address)  on  04/28  at  11:20 AM

So as oil prices accelerate upwards we crunch the rest of the economy harder and harder to maintain price stability?  Jeez, no wonder they call it a ‘blunt instrument’

A question for anyone reading:  Is there any chance that oil prices will fall in the absence of a global slowdown? (before, say 2020)

I can’t see it myself.  Seems to me that if the world keeps growing oil is headed to the moon.

P.S. Looks like its gonna zoom through $120 today.

Posted by .(JavaScript must be enabled to view this email address)  on  04/28  at  05:41 PM

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