McKibbin, Quiggin, Holden: RBA must target nominal growth

The titans of Aussie monetary policy, from across the ideological spectrum, have come together with a great idea, at the AFR:

The current monetary policy regime in Australia is “inflation targeting” –keeping inflation in a band between 2 per cent and 3 per cent over the cycle. Inflation targeting served Australia well for a long period from its adoption in the 1990s. It defeated the wage-price spirals of the 1970s and 1980s, where the expectations of high inflation caused high wage demands, which in turn led inflation to be high.

…The question that needs urgent attention is: what is the appropriate monetary framework in a post-COVID-19 world?

The world in 2020 is very different to that of the 1990s and 2000s. Well before COVID-19 struck it was clear that many countries, including Australia, were suffering from what former US Treasury secretary Larry Summers – picking up on an old idea due to Alvin Hansen – termed “secular stagnation”.

…The inflation target is no longer credible – yet credibility is its raison d’etre.

…In light of these considerations, rather than targeting inflation, a better approach would be for central banks, including the RBA, to target some measure of nominal income such as the level or growth rate of nominal gross domestic product. The economy’s nominal income is the money value of what the economy produces each year, including both the volume of goods and services (or real GDP), and changes in the prices of these goods and services (or inflation). This is still a clear policy rule that can be used to anchor expectations, like inflation targeting, but it has several advantages compared to inflation targeting.

This is a great idea insofar as it lets you run inflation hot to help deflate debt and dodgy assets.

The problem is in the implementation. What does the RBA print and buy to lift nominal growth and inflation?

Why buy reams of government debt, when the government won’t spend it?

So, does the RBA buy houses? Stocks? Junk bonds?

In short, if you don’t first reform fiscal, both budget and tax code, then all the inflation will either go into the worst possible places or nowhere at all.

And deflation expectations will embed anyway.

David Llewellyn-Smith
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