Australian Economy

Nobel Prize winner Joseph Stiglitz questions the Reserve Bank’s inflation target band

“In fact, economic research argues when the economy is going through a transformation, and we are going through a transformation … you want to have probably a higher rate of target for your inflation.”

The suggestion the target was “pulled out of the thin air” had some economists smarting.

‘A very considered judgement’

“I’m a great fan of Joseph Stiglitz, but I was a bit taken aback by that comment, [that] our inflation target was plucked out of thin air,” said Bernie Fraser, who was RBA governor when the target was created.

Mr Fraser said even though there was very little scientific literature around in 1993, it was a “very, very considered judgment” based on other central banks’ experiences, and monetary policy and macroeconomic history.

Recently departed deputy RBA governor turned chief financial officer at Andrew Forrest’s Fortescue Future Industries, Guy Debelle, made the following observation on the 25th anniversary of the RBA’s target in 2018.

“There is also now a large academic literature supporting inflation targeting and examining and advising on various questions about the appropriate design and operation of the framework,” Dr Debelle said.

And although that research also raised some questions about the features of the framework, “the proof of the pudding has been in the eating”, with 25 years of stable inflation and very satisfactory macroeconomic outcomes.

Professor Stiglitz says the rise of China over the past two decades has played a significant factor in the low rate of inflation. AP

When pushed by The Australian Financial Review, Professor Stiglitz doubled down, reiterating the lack of academic literature supporting the creation of an inflation target of between 2 per cent and 3 per cent.

Further, he said, there was little evidence the stable, low-inflation environment of the past two decades was a result of monetary policy.

“Was it the central bank saying we want 2 per cent that led to the low inflationary era? Or was it the fact that China suddenly was producing a massive amount of goods at very low prices?” he said.

“In a sense, it wasn’t monetary policy that drove the low prices, but globalisation and China. There are these different theories of why we’ve had low inflation. But whatever your theory is, we’re in different world now.”

China ‘Cold War’ risk

In particular, Professor Stiglitz is concerned about growing political tensions between China and the West. “The reality is, we may be in a cold war with China and that supply of cheap goods from there may be limited,” he said.

With institutions such as the Bank of International Settlements suggesting that in stable, low-inflationary regimes such as Australia, inflation was more heavily driven by global forces – such as overseas goods rather than domestic monetary policy – which could make returning to target a difficult prospect.

“I see a very strong distancing from China … I think anybody just making a reasonable forecast of where we are going as a world, I think there’s a high probability that there will be more decoupling,” Professor Stiglitz said.

“How far this will go? I don’t know. But there clearly is a process of decoupling going on and economic policy has to take that into account.”

In Australia during July as a guest of the left-leaning think tank The Australia Institute, Professor Stiglitz is speaking in Sydney, Melbourne, Canberra and Hobart on the role of government in the modern economy.

The widely published author, who won the Nobel Prize in 2001 for his work on information asymmetry in market transactions, has met Prime Minister Anthony Albanese and Assistant Treasurer Stephen Jones, as well as others in the Labor government, unions and the competition regulator.

World Bank warning

Professor Stiglitz said that in his conversation with Mr Albanese, he raised the issue of intellectual property waivers for vaccines, in particular COVID-19 vaccines, which he hoped the Labor government would take an active role in raising as a concern at the World Trade Organisation.

He also expressed concern that the World Bank was not taking a more proactive role on climate change.

With cost of living front and centre for many people, he said more could be done to provide support using fiscal policy by reducing or delaying expenditure in one part of the federal budget and using that money to provide support to low-income earners.

“People in the bottom, if they don’t get help, the impacts will be very serious and long-lasting,” he said, though he moderated his suggestion about using a super profits tax in an Australian context given the potential inflationary consequences in an economy with a 48-year low 3.5 per cent unemployment rate and near record levels of employment.

The question, he said, was ultimately how much inflation was being driven by supply side factors versus how much was being driven by domestic demand.

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