Independent senator Nick Xenophon is proposing a radical change to a core plank of Australian economy policy, arguing that the Reserve Bank of Australia should abandon inflation targeting to favour growth instead.
The RBA traditionally has a mandate to keep inflation between 2 and 3 per cent over the course of the business cycle. The overwhelming majority of its interest rate cuts have followed data prints in the consumer price index which have shown inflation to be either contained or falling.
But central banks around the world are wrestling with how to stoke inflation in an age using interest rate cuts when working populations are falling, technological innovation is keeping a lid on prices, and borrowing costs are at ultra-low levels.
The South Australian senator argues in a piece published in Fairfax Media today that the retirement of Glenn Stevens and his replacement with Philip Lowe next months presents an opportunity for a new deal with the government to target economic growth rather than inflation.
Wages are growing at recessionary levels, profits for small and medium-sized businesses are flat and the budget deficit constrains government spending.
Overall, Australia’s “nominal” growth rate – the growth in actual money in our pockets – has fallen from 7 per cent per annum in the decade before the GFC to only 2 per cent today.
Part of this so-called “income recession” is a hangover from the end of the mining boom.
A large part of it is also due to the out-of-date inflation target that the Reserve Bank of Australia has been tasked with hitting.
Xenophon notes that the RBA governor typically strikes a contract with the Treasurer on the agreed targets for overall economic policy and says that inflation-targeting is now clearly outdated, a view which is becoming increasingly advanced by economists around the world. When people see inflation at low levels and believe it is not going to rise very much, companies are less likely to hand out large pay increases and workers are less likely to seek them.
Inflation-targeting played its part in helping Australia move beyond the boom-bust cycle of the 1970s and ’80s. That does not mean inflation-targeting represents the end of history for monetary policy. As a nation, we can do better than we have been doing and smarter policy is the way to get there.
Incoming RBA governor Philip Lowe is due to take office on September 18.
If Governor Lowe and Treasurer Scott Morrison jettison the outdated inflation targeting approach for nominal GDP growth it will represent a sea change in monetary policy that would help kickstart the economy.
For a government that has seemed all at sea lately, that has to be a good thing for it – and us.
What’s unclear here is exactly what measures the RBA might be able to take to stoke growth. But Xenophon opened the door for an interesting debate.
The full column is here.
The question of whether central banks are “fighting the wrong war” was the key topic in this weeks’ Devils and Details podcast from Business Insider Australia, featuring BetaShares chief economist David Bassanese. You can find it on iTunes or listen in to the discussion below.