Working Papers

Who Lost the ‘War on Inflation’?

The December quarter CPI is nothing less than disastrous.  The 3.6% y/y average outcome for the statistical underlying measures is the worst result for underlying inflation since the great disinflation of the early 1990s and well above the 3.25% forecast in the RBA’s November Statement on Monetary Policy.  It is sobering to recall that these measures are preferred by the RBA because they capture the persistent component of inflation that forecasts future inflation outcomes. 

The government talks about a ‘war on inflation,’ but that war was lost by the RBA long before today’s CPI release.  Amid all the finger-pointing between the federal government and opposition, few have bothered to point out that the Reserve Bank is the only public institution in Australia with a specific mandate to control inflation.  Inflation is not some unfortunate exogenous event, unrelated to past monetary policy actions.  The inflation target breach tells us that the RBA was not doing its job properly 12-18 months ago.  In the US, the current and former Fed Chair are widely criticised for their supposed role in financial market problems not of their own making.  Yet in Australia, the RBA’s senior officers still enjoy almost unimpeachable authority while at the same time failing to meet their core mandate. 

If the RBA’s November Statement on Monetary Policy forecasts were realised, the RBA could perhaps have sat on its hands with a view to riding out the inflation target breach over the next 12 months and hope that international and domestic growth weaken sufficiently to return inflation to target in 2009.  The risk in doing so is that the RBA ends up validating an acceleration in domestic inflation, requiring an even more aggressive tightening response down the track, with greater downside risks for the domestic economy.  The tragedy of the RBA’s policy error on inflation is that it now has much less flexibility in responding to the deteriorating global growth outlook.  The RBA can be expected to raise rates at its February Board meeting, despite continued equity market volatility and aggressive Fed easing.

posted on 23 January 2008 by skirchner in Economics, Financial Markets

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Hi Stephan,

I did your monetary economics subject last semester.

Can I check with you what the core inflation measure is - this is the RBA’s weighted-median right? According to the RBA website, this rose 3.8&#xyo;y in Q4. Am I looking at the wrong measure?


Posted by .(JavaScript must be enabled to view this email address)  on  01/23  at  03:06 PM

The RBA takes the average of the trimmed mean and the weighted median as its measure of underlying inflation, so its the average of 3.4% and 3.8% respectively.  Of course, they have never really explained this properly, but it’s in the footnotes to the SOMP forecasts.

BTW, well done on your result last semester.

Posted by skirchner  on  01/23  at  03:43 PM

Thanks Stephan, that makes lots of sense now

(and thanks for the uni grade and subject too - I enjoyed the course)

Posted by .(JavaScript must be enabled to view this email address)  on  01/23  at  03:54 PM

Alan Wood gave you a plug while discussing this very topic.

Posted by benson  on  01/24  at  02:06 AM


Are you suggesting the Fed is lowering rates due to political pressure resulting from the sub-prime issue and election year rhetoric at the expense of inflation pressures?  If so, do you see inflationary problems down the road resulting from the monetary decisions being made today?  And lastly, do you think the (seemingly) worldwide rise in inflation going on now is primarily a result of commodity prices, or is it more a function of past monetary policy?  I guess I’m kind of unsure how much of inflation is commodity based and how much is monetary policy, or maybe commodity price rises are a function of monetary policy.  I’m aware of what Friedman said, but that seems to ignore demographics and changing economic systems, ie China.

Sorry for all the questions, I just like your thoughts better than most.  Thanks, Chris

Posted by cb  on  01/24  at  04:30 AM

Chris, don’t have a problem with the Fed’s actions and don’t believe they are politically motivated.  In relation to commodity prices, monetary policy would be a minor influence on the supply and demand imbalances that have driven rising commodity prices.  The policy question is how much commodity price inflation is allowed to flow through to consumer prices and over what time frame.  Greenspan notes in his book that he had it easy in the 1990s when commodity prices were falling (same goes for Governor Macfarlane here).  It is only now that some of the new monetary policy frameworks are being put to a serious test of their inflation fighting credentials.

Posted by skirchner  on  01/24  at  08:12 AM

If a central bank lowers rates to stimulate the economy it is the wrong reason for the decision. If, however, they cut the interest rate because inflation is within the target range and they can afford some slack, then it’s the right reason.

The central bank should focus on inflation, nothing else. If there’s a downturn, but inflation is within the target range, then rates should not be lowered to stimulate the economy. This puts pressure on governments to increase economic activity by lowering taxes (which is a desirable objective anyway). I would take higher unemployment over unwanted inflation any day.

Posted by Sukrit Sabhlok  on  01/27  at  12:06 PM

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