The need for a new monetary policy framework

My Submission to RBA Review Panel

My submission to the panel reviewing the Reserve Bank of Australia has been published on the review website. Here’s the abstract

The primary purpose of this submission is to argue that the currently dominant framework for monetary policy, based on strong central bank independence and reliance on adjustments to central bank interest rates to achieve a 2-3 per cent inflation target has performed poorly at a global level and is no longer sustainable. A new framework, accepting a higher average rate of inflation and taking explicit account of the objectives of full employment and economic prosperity is needed.

Here’s some key points.

• The RBA Act requires the Reserve Bank to exercise its powers ‘in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to’:

(a)  the stability of the currency of Australia;

(b)  the maintenance of full employment in Australia; and

(c)  the economic prosperity and welfare of the people of Australia.

More briefly, these objectives may be specified as referring to inflation, employment and national income. The RBA has placed too much attention on inflation at the expense of

• The Non-Accelerating Inflation Rate of Unemployment (NAIRU) is neither an observable target nor a suitable measure of full employment. Full employment should be defined as a situation in which the number of unfilled vacancies is approximately equal to the number of unemployed workers

• Inflation targeting policies have performed poorly in most countries. Australia has avoided the worst consequences only because of the use of sustained fiscal stimulus in the GFC and Covid emergencies

• To the extent that an inflation rate target is maintained, it should be of the order of 4-5 per cent, to avoid repeated periods of zero or near-zero interest rates

• It would be preferable to focus on a measure, such as nominal national income, which explicitly incorporated a measure of output growth

• Macroprudential policies should be used to target asset price inflation

• Fiscal and monetary policy should be co-ordinated