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Fiscal vs Monetary Policy: RBA Independance and Inflation Target not Sacrosanct? Chris Joye; Inflation targeting facing unprecedented challenge. Can the Reserve Bank of Australia abandon inflation target?
Topic Started: 3 Aug 2011, 10:16 AM (6,286 Views)
Strindberg
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Enjoy The Ride
18 Aug 2011, 06:27 PM
Strindberg- Finally I agree with your comments, Inflation is a hidden tax on the people it serves no meaningful purpose. The inflationista's don't realise this is a very dangerous game for central banks to play. Once the population has high inflationary expectations inflation tends to gain momentum on its own. The cure will be more painful than the disease.
We are beginning to see the folly of Keynes, his theory is essentially right. BUT you cannot trust central banks anywhere in the world to price capital correctly in the economic boom times, this is where the mistake is made. Turning to Keynes to stimulate an over stimulated economy will just make the situation worse, it is the malinvestment of capital that created the problem. More of it will not solve it.
Anyone got a ZIM 10,000,000,000 note? how did that work out.




Enjoy The Ride!
You may have misunderstood me.

I was pointing out that the RBA are not following their legal duty as defined in the Reserve Banking Act. There is no way they are maintaining the stability of the currency however that is defined. Therefore they are in breach of their legal duty.

However, I did not say that I agree with the Reserve Banking Act that the stability of the currency should be maintained. You appear to have assumed that I support that objective as a legal duty. I do not.

Control of inflation can only be seen as a means to an end, it cannot be an end in itself. The ends which the RBA should be trying to achieve are embodied in the other two objectives ie full employment and the well being of Australians. The means of achieving such ends should not be incorporated into law. Flexibility is required. The issue of inflation is complex and there is no natural law which dictates a firm policy. The policy with regard to inflation should be subject to circumstances and not subject to law. Economists do not all agree on how to deal with inflation. The current anti-inflation views held by people like yourself arose from the influence of Milton Friedman in the 1970s and1980s but we can't know that even Friedman himself would not have changed his mind on some issues in the circumstances in which we now find ourselves where inflation may be the result of external factors not responsive to traditional CB responses.

Having a law which requires the maintenance of the stability of the currency (ie 0% inflation or even 2-3%) is an unnecessarily restrictive straight jacket which law makers cannot know will provide the best outcome. If a law calls for the elimination of inflation and that process results in massive unemployment and the impoverishment of Australians then the law is an ass.

I well remember the high inflation of the 1970s. I don't recall any great widespread impoverishment.

PS - yes, I disagree with Joye on this issue.



Edited by Strindberg, 19 Aug 2011, 12:14 PM.
Housing costs to Income broadly unchanged since 1994 - re-ratified here
The People of Australia have the highest median wealth in the World
2002-2012 10 year house price growth the SLOWEST since 1952-1962
"There are two kinds of people in this world: ones that fiddle around wondering whether a thing's right or wrong and guys like us." (Hugo to Gagin in Ride the Pink Horse)
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Enjoy The Ride
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Strindberg
19 Aug 2011, 12:08 PM
Enjoy The Ride
18 Aug 2011, 06:27 PM
Strindberg- Finally I agree with your comments, Inflation is a hidden tax on the people it serves no meaningful purpose. The inflationista's don't realise this is a very dangerous game for central banks to play. Once the population has high inflationary expectations inflation tends to gain momentum on its own. The cure will be more painful than the disease.
We are beginning to see the folly of Keynes, his theory is essentially right. BUT you cannot trust central banks anywhere in the world to price capital correctly in the economic boom times, this is where the mistake is made. Turning to Keynes to stimulate an over stimulated economy will just make the situation worse, it is the malinvestment of capital that created the problem. More of it will not solve it.
Anyone got a ZIM 10,000,000,000 note? how did that work out.




Enjoy The Ride!
You may have misunderstood me.

I was pointing out that the RBA are not following their legal duty as defined in the Reserve Banking Act. There is no way they are maintaining the stability of the currency however that is defined. Therefore they are in breach of their legal duty.

However, I did not say that I agree with the Reserve Banking Act that the stability of the currency should be maintained. You appear to have assumed that I support that objective as a legal duty. I do not.

Control of inflation can only be seen as a means to an end, it cannot be an end in itself. The ends which the RBA should be trying to achieve are embodied in the other two objectives ie full employment and the well being of Australians. The means of achieving such ends should not be incorporated into law. Flexibility is required. The issue of inflation is complex and there is no natural law which dictates a firm policy. The policy with regard to inflation should be subject to circumstances and not subject to law. Economists do not all agree on how to deal with inflation. The current anti-inflation views held by people like yourself arose from the influence of Milton Friedman in the 1970s and1980s but we can't know that even Friedman himself would not have changed his mind on some issues in the circumstances in which we now find ourselves where inflation may be the result of external factors not responsive to traditional CB responses.

Having a law which requires the maintenance of the stability of the currency (ie 0% inflation or even 2-3%) is an unnecessarily restrictive straight jacket which law makers cannot know will provide the best outcome. If a law calls for the elimination of inflation and that process results in massive unemployment and the impoverishment of Australians then the law is an ass.

I well remember the high inflation of the 1970s. I don't recall any great widespread impoverishment.

PS - yes, I disagree with Joye on this issue.



Strindberg- sorry for jumping the gun one day we may actually agree on something.
I have a hard time with the notion that Central Banks are some kind of precision instrument that can tinker with the economy to get the desired results. I would rather they keep an inflation target at all costs, this way everyone knows the rules and plays the game.
When we get central banks riding to the rescue on their white horses, as the US FED did in the asian financial crisis, dot com bust, 911, and in 2008, the markets start thinking central banks are there to take risk off the table. Wall st. called it the Greenspan put.
The risk in dropping the inflation target is too great, inflation targets give integrity to Fiat, without them we will see Gold an Silver make new highs on a regular basis, it is a short step to hyper- inflation as no one wants to be left holding the cash.
Chavez asked for Venezuelas Gold back from the bank of England yesterday, do you think he will settle in cash?




Enjoy The Ride!
Enjoy The Ride!

The case for individual freedom rests chiefly on the recognition of the inevitable and universal ignorance of all of us concerning a great many of the factors on which the achievement of our ends and welfare depend. It is because every individual knows so little and, in particular, because we rarely know which of us knows best that we trust the independent and competitive efforts of many to induce the emergence of what we shall want when we see it. Humiliating to human pride as it may be, we must recognize that the advance and even the preservation of civilization are dependent upon a maximum of opportunity for accidents to happen.”
― Friedrich A. von Hayek


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Catweasel
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Strindberg
19 Aug 2011, 12:08 PM
You may have misunderstood me.

I was pointing out that the RBA are not following their legal duty as defined in the Reserve Banking Act. There is no way they are maintaining the stability of the currency however that is defined. Therefore they are in breach of their legal duty.

Catweasel say oh the nature of flippant zealot mind. It do the accuse of a RBA effectively a treason against a Australian mouse. On another of the hand, it the first to scream its faith of a RBA to pull a lever to make price of a debt cheap.

In a reality, it just do a say of first thing to placate its emotion. This a what a worry. Very little the expansive think in a Australia. It all just a reactionary with jury-rig of theory that sound pleasant to it. A Strindbag not alone. It a national disease.
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mugshot
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Strindberg
19 Aug 2011, 12:08 PM
PS - yes, I disagree with Joye on this issue.


Joye seems to be coming round to your way of thinking!

Kudos to Fairfax's Peter Martin/Tim Colebatch on the CPI

Peter has a very good article in today's paper outlining the case for a one-off rate cut.
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http://christopherjoye.blogspot.com/2011/10/ozs-uren-inflation-targeting-and-rba.html

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The Oz's Uren: Inflation-targeting and RBA independence *not* sacrosanct

For over a year I have been discussing the "fiscalisation" of monetary policy and the politicisation of central banking independence (some blithely question whether this is a concern in Australia). If there were any doubt, The Oz's senior economics correspondent, David Uren, sympathises with those who would tolerate higher inflation and a less independent central bank in his column today, entitled, "The RBA's inflation target not sacrosanct":

"[A]s Stevens and his colleagues travel to their regular meetings with peers from around the world at the Bank of International Settlements (BIS), they must be aware that inflation targeting is facing an unprecedented challenge.

Australia, with its healthy growth, low unemployment and still low government deficits and debt, can sail on regardless, but it is unlikely that inflation targeting would survive a new world downturn here or anywhere else in its current form.

The first line of attack, which emerged as the 2008-09 crisis was unfolding, was that simply targeting inflation did nothing to prevent ultimately destructive financial imbalances from building up...

In a world in which fiscal policy is dominant, the dogged pursuit of inflation targeting leads to more volatile inflation and higher sovereign risks...

[Morgan Stanley's] Pradhan says that while a country is trying to close large budget deficits, "monetary policy serves its inflation fighting credentials best by not fighting inflation aggressively".

The theory of inflation targeting said that it would be most effective with a conservative central banker whose ability to fight inflation credibly was reinforced by giving the central bank independence.

However, under large budget deficits, this approach is likely to prove disruptive. Pradhan cites the European Central Bank's decision to lift interest rates this year in the face of a weakening economy and massive sovereign debts as a destabilising influence.

He says that emerging market nations in both Latin America and Asia were able to emerge from financial crises in the late 90s by focusing on getting their budgets under control, while tolerating slightly higher inflation. "The fact that emerging market central banks were not quite as independent as their counterparts in the advanced economies actually helped," he says...

The IMF's Blanchard caused outrage early last year when he suggested that inflation-targeting central banks might do well to tolerate slightly higher inflation and interest rates.

He argued this would give central banks greater flexibility to lower rates during recessions without hitting the lower zero interest rate limit...

However, around the world, other central banks are dealing with the trade-off of fiscal and monetary policy. The Bank of England announced two weeks ago it would engage in a further round of quantitative easing, buying the government's bonds, at the same time as the inflation rate hit 5.2 per cent.

At the heart of the European crisis is the European Central Bank's reluctance to do anything more to ease the sovereign debt crisis than buy government bonds on the secondary market."
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The bulwark of central bank independence

The principle of central banking independence embodies a long-standing truth about elected officials. That is- at their core, they know they will do nearly anything to be re-elected, whether or not it is in the best interests of their constituents. So they divest themselves of the most important powers before such unduly temptations can arise.

Out of all the decisions and duties we have vested in the powers at be, monetary policy is one of the most direct. (Of course, it is highly nuanced and exceedingly difficult in practice.) So formulaic that Milton Friedman very seriously proposed that it would be better managed by a computer, for which an economist would simply design the rules and press play.

So why can't we entrust central banking to politicans? Because they would never, ever, raise interest rates as far or as early as they should. In Australia, home ownership is not only the greatest province of adulthood - it's also where all the wealth is. And two thirds of voters have already paid the upfront cost.

Like Odysseus sailing through the Sirens, lashed to a mast, the Prime Minister of the election year will always still be tempted by a siren song- to try to force the hand of the Reserve Bank cut interest rates. Odysseus also knew he would renege on his commitment to resist his temptations halfway through his course- and so forced the sailors to fill their ears with wax, so that they would be deaf to his irrational cries to sail to the beautiful, but perilous island.

Central bankers know that politicians agreed that monetary policy should focus on price stability before they set sail. And so when the politicans play the rent-seeking siren songs of the unions and manufacturing industry slash residential investment (Labor slash Liberal), they should continue to follow their initial directions with wax firmly in eardrums.

The mast binding our government is statutory- overturning the RBA policy and/or governance is difficult - it requires approval from the governor general and both houses of parliament. It has never been invoked. Things did not always work this way- before McFarlane (1996), the RBA governor would have to propose the policy to the government, who would issue the statement.

For this reason, Gillard's call for lower interest rates from the RBA should fall on deaf ears. That is not to say the Bank won't lower interest rates at the next meeting. Particularly after the very soft export and import price data we've had this week, the balance of indicators has turned and they probably will. Rather, they should and will do whatever they would have decided if she had never spoken. And they have before- Costello did the same in 2007 when the incumbents were, again, fearful of losing an election. Headline inflation was just below the band, but underlying was high. The RBA hiked.

So then, is it appropriate for politicians to speak about lowering interest rates at all- or does it undermine the bulwark of Central Bank independence?

The answer is yes- it is perfectly appropriate, but not at all in the way the Prime Minister has done.

The Statement on the Conduct of Monetary Policy explicitly states: "Consistent with its responsibilities for economic policy as a whole, the Government reserves the right to comment on monetary policy from time to time." It would be ridiculous for the government to be unable to speak of the effects of monetary policy, and the fact that delivering a surplus would take some heat off monetary policy.

The interest rate is a blunt instrument with large social costs- a high one depresses the manufacturing and retail industries and puts individuals out of jobs; a low one fuels asset prices and unaffordable housing. The government has a responsibiltiy to appropriate fiscal policy, to ensure the cash rate doesn't stray too far from neutral- and if it forms part of the rationale for a surplus and deficit, it is very appropriate to say so.

But the PM has it the wrong way around. If the economy is operating so strongly that interest rates are well above neutral, then commenting that a surplus would give room for the RBA to ease is entirely correct. This is the opposite of what we see in the PM's speech: "to all those calling for rate cuts, you should also be calling for a surplus - not opposing one." In a coming speeches to abate the rent-seekers in the retail and manufacturing industries, I expect the declaration: "to all those who believe global warming is too rampant, you should be buying more coal-fuelled air conditioning units - not less!"

And again: “In the current economic environment, should the RBA consider it appropriate to change the cash rate, this could deliver widespread benefits for households and business – noting that a number of sectors of the economy most under strain are arguably more sensitive to interest rates.

Stevens has done his best to communicate- rightly- to the Government and public that monetary policy is the wrong instrument to target individual sectors- and the government needs to focus on industry-level industries. I can imagine he sits in ghast disbelief at the inattention.

In a similar vein of contradiction, the PM states that: the RBA should pursuing a lower rate of policy would be consistent with the mandate to "best contribute to economic prosperity and full employment." According to the AFR, the original speech made "the case for a reweighting of monetary policy which could help push down the ­Australian dollar and provide relief to manu­facturers, exporters and the tourist industry."

This rings directly with Howes' point, which we were told was supposedly firmly rejected by Gillard and Swan, that: “The RBA’s obviously got a charter to deal with inflation. We know the importance of that. But they have the most ability to impact on the Australian dollar. We believe very strongly that they need to cut rates to put downward pressure on the Australian dollar.”

The Government's handling of the economy in the last 3 years showed grit, political will and courage in the face of rampant (and rampantly incorrect) criticisms about the necessity of eternal surpluses. It would be a shame to discard all that of that credibility and consistency now.

Read more: http://radicalexpectations.com/the-bulwark-of-independence
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