The RBA holds a position of high-esteem in Australia, enjoying almost universal support in politics, business and the media. Part of the reason for this respect (bordering on reverence) is the credit the RBA is given for Australia's long boom over the last fifteen years or so.
In the fifth lecture of his excellent 2006 Boyer series former RBA Governor, Ian MacFarlane, says:
The 1990 recession returned Australia to low inflation and paved the
way for the sort of stability—15 years and counting—that earlier
recessions had failed to achieve. Through the 1990s sustained economic
growth re-emerged, and a new approach to monetary policy based on
inflation targeting and central bank independence was put in place.
While this independence has become an article of faith with politicians in Australia, and throughout much of the world, not everyone is sanguine about it. For instance, University of Western Sydney economics professor Steve Keen recently wrote:
the last two decades have been a period of unprecedented
independence for Central Banks. After the high inflation of the 1970s
and 80s, when politicians were last in direct control of monetary
policy, politicians willingly ceded control to the Central
Bankers–largely to avoid the political pain of being blamed for high
interest rates.
Inflation has certainly been lower since the Central Bankers too
over, but at the same time there have been more–and ever
larger–financial crises than when politicians held the reins. We’ve had
the Asian Financial Crisis (1997), the Russian Financial Crisis (1998),
the Long Term Capital Management Financial Crisis (1998), the Internet
Bubble and NASDAQ Financial Crisis (2000), and now, the Subprime
Financial Crisis–all since Central Banks cast off the shackles of
political control.
That’s not a track record that inspires the confidence in Central
Bankers. I’d be inclined to give them less independence, rather than
more, on that evidence alone.
Yesterday, Columbia University economist Joseph
Stiglitz said "inflation targeting by central banks may lead to a
``disaster'' and that it was ``absurd'' for the Reserve Bank of
Australia to think it could dampen global food and energy prices".
It is unlikey that the RBA is unaware of its inability to control the external factors that are feeding into Australian inflation. In the minutes of their most recent Board meeting they say:
the increase in prices over the past year had been broadly based, with
three-quarters of the items in the CPI basket, by weight, rising faster
than 2.5 per cent per annum. Non-tradables prices, mainly comprising
services, had picked up noticeably. Tradables prices excluding the
volatile components of food and petrol were rising at less than 1 per
cent per annum, and had been held down by the effect of the higher
exchange rate. International comparisons suggested that inflation in
Australia, on both a headline and underlying basis, had for some time
been noticeably higher and was now rising more steeply than the average
of the G7 economies excluding Japan. This reflected the relatively
stronger demand conditions prevailing in Australia in recent years.
There are two points here. Australia's inflation rate is higher than comparable countries because of demand conditions in this country and, more importantly, the RBA sees its task as being one of trying to prevent persistent high inflation from feeding into ongoing wage and price-setting behaviour. That is seen as the real problem that could cause a return to the boom / bust cycles of the 70s and 80s and the consequent negative constraint on long-term economic growth rates.
Nevertheless, there is still an argument that this desire to avoid inflation being factored in needs to be balanced against the pursuit of another key objective, avoiding a recession. Former Liberal leader, John Hewson, has been to the fore in arguing for more flexibility in inflation target-setting in recent weeks.
Interestingly, a main argument for sticking with the current inflation targets is that a more flexible target would undermine the confidence of the RBA and, consequently, add to inflationary targets. For instance,
Westpac chief economist Bill Evans said the architects of the policy
in the 1990s would have set the band higher if they had known commodity
prices were going to enjoy such a large boom.
"With a 64 per cent increase in the terms of trade (the ratio of
export to import prices), the inflation target is creating a bit more
of a challenge," Mr Evans said.
"But having adopted the target, we have to stick with it or there
would be an alarming loss of credibility that I don't think any central
bank would want to contemplate. It would risk too much spill-over into
wages and prices."
On the other hand, a recession that was believed to be the result of too many interest rate rises by the RBA might result in a serious long-term credibility problem for Australia's central bank and a greater questioning of its independence. Politics like business goes in cycles.
Postscript. America's Federal Reserve is also having enormous difficulty setting interest rates in the current climate: "Fed officials chose to lower their benchmark interest rate by a
quarter-point at their last meeting, in late April. But the minutes of
the meeting revealed deep divisions among the bankers, who acknowledged
the “difficulty of gauging the appropriate stance of policy in current
circumstances.” Minutes.
