Abandon inflation targeting while we still have time

Back in 2012, I wrote a piece arguing that Australia should abandon the policy of inflation rate targeting, and switch to one in which the target was the level of nominal GDP. As I argued then, inflation targeting is part of a package deal involving a number of propositions, most particularly
* Macroeconomic management should be left to an independent central bank
* Successful inflation targeting will also stabilize real GDP, and therefore fulfil the dual mandate of price stability and full (or as full as possible) employment
* The best policy approach for central banks involves modest regular adjustments of a key interest rate. In Australia this is the cash rate, which is the overnight money market interest rate.

The idea of nominal income targeting has recently been put forward by .Nick Xenophon and economist Danny Price, in relation to the contract with the new Governor of the Reserve Bank, Phil Lowe. The article mentions my support, and I commented on an earlier draft.

Writing in Crikey, Bernard Keane and Glenn Dyer criticise the idea, making three points
(a) Unlike other countries, we are not yet at the zero lower bound, so we can continue using interest rate policy
(b) Macroeconomic outcomes in Australia have been pretty good under inflation targeting
(c) A nominal GDP target can’t be achieved using monetary policy alone, we need fiscal policy as well.

My response to point (c) is “Yes, that’s the point of the shift. When we dump inflation targeting, we dump the entire package, including exclusive reliance on monetary policy”. On (a) and (b), it seems to me more sensible to make the change when we can, rather than be in the position of most countries, where inflation targeting remains notionally in force, but in practice the only instrument available is open market security purchases (aka quantitative easing). And in all those countries, macro outcomes in the inflation targeting era have ranged from poor to disastrous.

Although Australia is doing well right now, interest rates are heading down, and would certainly hit zero fast in the event of a crisis. So why not fix our policy now, while we still have time.

49 thoughts on “Abandon inflation targeting while we still have time

  1. Ernestine Gross :
    “One thing is for sure, during a crisis, all options will be on the table if need be…”
    I do not recall any non-trivial period of time when there was no ‘crisis’ of one kind or another. Still, the option I’ve hinted at is not on the table.

    Income equality? Well… yeah… that lever is permanently welded to the chassis.

  2. Newtownian :
    An interesting topic but its one to which one might ask “is it actually too late?” . I ask as I’m just emerging groggily from reading Satjayat Das’s book “A Banquet of Consequences”. (Before plunging into Mervyn King’s opus “The End of Alchemy” which bizarrely seem to suggest the 1990-2006 period was all rosy rather than the time when the current mess was set in motion through financialization”).
    I didnt encounter much new in Das’s book but it was good to see all the competing forces lined up together and to a degree integrated in one place. Problematically the book suggests that the backlashes from any financial engineering undertaken now will be dire, whichever way things evolve because of the legacy of the past 35 Years – and especially the failure to do anything new in the past 8 years. Das’s conclusion seems to be we have been now locked into a crash by the inability to disentangle the global financial Gordian Knot, the only question is whether it will be slow or fast motion.
    So bearing his arguments in mind its interesting that you suggest for Australia is currently all right. But from where I sit on the verge of retirement interest rates are terrible for those trying to survive on superannuation in the longer term – they are better than the US, but they arent enough for 20 years or more retirement even without medical bills. The alternatives seem to be to invest in a vastly inflated stock market or an unproductive housing bubble i.e. no choice at all.
    Conversely if interest rates do rise the mortgage impacts on intending and recent buyers would bring down the house(ing market).
    If I understand his arguments correctly there is just too much unproductive saving and simultaneious accumulated debt in a system and without someone losing say through quantitative easing, this situation will only get worse. Also the status quo is only kept going by a kind of hopeless faith in the need to keep dancing of the kind familiar to admirer’s of the depression topic film “They Shoot Horses Don’t They?”.
    Comments? In particular what are the dangerous potential blowbacks from what is suggested above with regarding to using GDP as a target?
    My impression is that it will be extremely hard to stimulate GDP because of the extent to which people are in debt overall or where they are hoarding as I probably am, its against the fear of a rainy day and the fact that I like so many older people dont actually need to buy that much as most of my material wants are satisfied.

    I have been pondering this from John Kay’s article “No savings glut, investment opportunities abound”

    The problem is not that there is a shortage of productive investment opportunities that will yield rates of return well above zero. The problem is that we have put barriers — institutional, political and economic — in the way of making these investments.

    Maybe the problem is much simply that a deliberate dismantling of the social infrastructure that mitigated personal risk for health and retirement has resulted in both a savings glut and a debt explosion driven by housing investment for retirement security.
    The private market is fundamentally inefficient at providing insurance and in a worse case scenario is underwritten by the state anyway. Lets cut out the middle man!

  3. @Troy Prideaux

    Looking back as long as I can remember as an adult, there has been a financial crisis somewhere in the ‘global economy’. Most of the time it happened in other places than where we live.

  4. Sorry – that was meant to be more concise – 2nd go

    Newtownian :
    …But from where I sit on the verge of retirement interest rates are terrible for those trying to survive on superannuation in the longer term – they are better than the US, but they arent enough for 20 years or more retirement even without medical bills. The alternatives seem to be to invest in a vastly inflated stock market or an unproductive housing bubble i.e. no choice at all.

    I have been pondering this from John Kay’s article “No savings glut, investment opportunities abound”

    The problem is not that there is a shortage of productive investment opportunities that will yield rates of return well above zero. The problem is that we have put barriers — institutional, political and economic — in the way of making these investments.

    Maybe the problem is simply that a privisation of social infrastructure that mitigated personal risk for health and retirement has resulted in both a savings glut and a debt explosion driven by housing investment for retirement security.
    The private market is fundamentally inefficient at providing insurance and in a worse case scenario is underwritten by the state anyway. Lets cut out the middle man!

  5. @suburbanite

    I am very sympathetic to the content of your last paragraph. For example, the economic security of the currently ‘old’ depends on the productivity of the currently ‘young’ and the expectation of the currently young regarding their economic security when they are ‘old’ depends on the productivity of the future ‘young’ generation and so forth. So one may as well cut out the middleman – the bloated financial system. Financial securities cannot ‘secure’ much. They are only state contingent contracts for monetary payoffs at best.

  6. @Ernestine Gross

    We are already arguing past each other a bit. Your comment about “central planning” opens a whole, large discussion. I would need to take it to a new sandpit when such appears.

    Suffice it to say here, I am not arguing for a soviet-style communist command economy which in actuality turns out to be state capitalism. Of course, I would have to make the case supporting that thesis (or link to a paper) plus in turn make the case for a socialism or more socialism-biased mixed economy which is not merely, and indeed not predominantly, a centrally planned economy in the sense in which you seem to use that term. But as I said, it must be a sandpit discussion. I will await the appearance of a new sandpit… I hope.

  7. NGDP targeting is bogus since doesnt account for asset price rise and it will excaserbate the inequality.

    I propose much better targeting and also a policy instrument with it. It is wage increase targeting. Wage growth is the main source of inflation, second source is credit expansion where credit adds to demand and increases infation. Recent decades in US show that only credit can be the source of inflation without wage increase. And it was relied on credit expansion to grow wages trough housing sector.

    Policy instrument that can raise wages without government spending a dollar is only one; minimum wage.
    Policy instrument that would target wage increase is CB calculating a minimum wage that would move toward the desired target. There is a danger that target could be 0. This is extremely dangerous since debt economy requiers inflation of prices and wages in order to keep economy out of recession in medium and long run.

    Target for nominal wage increase should be around 2% since it is needed to lower the burden of debt over time.

    Another policy instrument for buying power instead of wage increase is to add points on credit scores for poorer sections of population and firms in sectors that need support. Credit score points make for lower interest rate and with it the burden of debt reduced. Ammount of points can vary as needed. This also reduces real inequality as what real is: it is the usage of the housing and products not ownership. Credit allows us to use what we do not own.
    Adding score points to credit score is making credits cheaper for lower incomes reducing the inequality of wages and injustice of unequaly rewarding giving time to corporations.

    Why is CEO’s time away from the familly rewarded much much much more then a cleaning lady’s time given to corporation? Giving cheaper credits to cleaning lady then to a CEO is countering a bit this grave injustice of capitalism.

    NGDP targeting completely misses the effects of asset price inflation just as inflation targeting does.
    The real solution is wage rise targeting with minimum wage and credit score points.

  8. @Ikonoclast
    Your #36 of 23 Aug.

    Well, if you’re into that kind of thing, Ikono, you’d love Henri Fayol. Here’s a bit of a sample:
    Fayol’s Principles of Management

    During the early 20th century, Fayol developed 14 principles of management in order to help managers manage their affairs more effectively. Organizations in technologically advanced countries interpret these principles quite differently from the way they were interpreted during Fayol’s time as well. These differences in interpretation are in part a result of the cultural challenges managers face when implementing this framework. The fourteen principles are:

    Division of work,
    Delegation of authority,
    Unity of commands,
    Unity of direction,
    Interrelation between individual interests and common organizational goals,
    Compensation package,
    Scalar chains,
    Job guarantee,
    Team-Spirit or Esprit de corps.

    Just Google Henri Fayol wiki and you’ll get a couple of entries:

    Henri Fayol – Wikipedia, the free encyclopedia
    Fayolism – Wikipedia, the free encyclopedia

  9. @GrueBleen

    DeLong’s essay is interesting more for where he doesn’t take the analysis than for where he takes it. Despite the promising title it ends up as a pro-corporation piece rather than a negative critique of the corporation as a command economy or autocracy or simply as an anti-competitive monopoly. It exposes the confusion in his overall position. However, when I attempt to analyse these matters (central command vs distributed autonomy) I discover confusion in my own ideological position – a different confusion – and I haven’t resolved it yet. I will look at Fayol. Thanks for the heads up.

  10. @hc

    Greber’s point is more of a nitpick than a fundamental objection. As I said in my 2012 piece, the aim is to target the sum of inflation and growth. That requires an inflation index. Most of the time this doesn’t matter, but during the minerals boom and bust there was a big divergence between the GDP deflator (which reflected export prices) and the CPI, which didn’t, at least not directly. Nominal GDP growth is the sum of real growth and inflation as measured by the GDP deflator, so, if this is treated literally we have the problem Greber mentions. But, as he implies, it’s easily fixed.

    The real issue is whether to include GDP growth in the target and here, Greber’s argument is very weak. More on this soon.

  11. @John Quiggin

    The devil would be in the detail, I guess. How would an inflation rate target of say 2.5% and a growth rate target of say 2.5% be targeted conjointly in practice? What are the specific macroeconomic levers or settings which would or might achieve these goals?

    It seems to me, in the current economic system, we have trouble targeting more than one thing at a time. Inflation can be knocked on the head if we don’t much care about unemployment and all the people it affects. We’ve seen that occur in practice under neoliberalism or market liberalism. Going by at least some episodes of high inflation it appears we can target lower unemployment at the expense of high inflation. Sometimes, with stagflation for example, it appears everything goes bad at the same time.

    You don’t explicitly mention (in this thread or the link) unemployment. How do you fit employment targets into this scheme? What takes priority, the nominal GDP target or social goals like full employment? Or is this the wrong question or one which misconstrues the problem? How do you answer questions about inflation measurement methods and the issue of largely unmeasured asset inflation?

    I don’t want to sound too snarky but you throw a bone with no meat on it. Maybe some of the economic cognoscenti can crack the bone and get the marrow out but the average person wants to know how social goals are to be met and/or which ones are to be sacrificed for nice numbers which not so incidentally tend to work best for those who already have wealth.

  12. @Ikonoclast

    Your #41 of 24 Aug

    Yep, our Bradley can be a little confused at times, but he’s usually an interesting, or at least informative, read.

    What you’ll get from Fayol – who dates from very early 1900s – is a view of the ‘command and control’ organisation as it was envisaged at the start of the ‘corporate explosion’ of the 20th century.

    But just have a look at Fayol’s 14 ‘principles’ for a corporation, and tell me how that differs from, say, a well run army – eg the Roman Legions – or a major religious organisation – eg the Roman Catholic Church (add in Roman concrete and we can begin to see how much our “Judeo-Christian European Civilisation” depends, not on the Greeks, but on the Romans).

    Fayol is an interesting, “this is how it got started” read whom I first encountered in 1974, along with Taylor, Gantt and Mr Therblig, aka Frank Bunker Gilbreth (and Lillian Moller Gilbreth, collectively aka Mr and Mrs Cheaper By The Dozen).

  13. @Ikonoclast
    Would wage increase target answer your question?
    Wage increase happens mostly in low unemployment environment (assuming there are no effective unions to demand higher wages which is present environment) naturaly, but minimum wage enables more borrowing by reducing burden of debt and wage growth across the scale.

    Since debt is a sufficiently large part of agregate demand and it is part of capitalist economy, increase of wages are necessery to reduce burden of debt and compounding interest rate problem.

    A monetary policy that targets wage increase instead of doing it indirectly trough interest rate would be more effective at GDP growth and unemployment. And also more effective at reducing inequality.

    Income (wages) is the starting point of agregate demand and also as the base for the credit issued. Income is the center point where everything starts but why is everyone scared to look at the center? Because it raises inflation? well, isn’t that the obvious mechanism?

  14. Why is everyone scared to take a look at my proposal? or is it a comprehension problem?

  15. Neither Job Guarantee nor Basic Income Guarantee by themselves would do a complete job of managing economy for the best outcome.

    Job Guarantee only if it is coupled with BIG can do a sufficient and controling job.
    Job Guarantee is needed not to let productive capacity go to waste, while BIG is needed to cover those temporarily unable to work.

    One policy catches what other policy lets through the cracks. But more importantly is the ability of private sector to colude with administration and abuse one or other policy prescription. Coupling BIG and JG would prevent the abuse of the system since give more controlling power to workers to switch between programs if they do not find it fulfilling and rewarding.

  16. @Jordan from Croatia

    Again, I am quite happy to agree. A Job Guarantee and a Basic Income Guarantee could and should work together. These would be consistent BTW with the propositions in the Aeon magazine article by John Quiggin – “Prospects of a Keynesian utopia”. The central thesis in that article is that productivity, aided by machines and automation, has reached a point where all people in a developed country can be given a reasonable, modern standard of living and that paid work, if scarce, can be shared around more. Some persons may even be permitted to opt out and “surf” or as I might suggest “think, write or get educated in something new.”

    Of course, the title of the article could also have been “Prospects of a Socialist utopia”. I say this to support the article not criticise it. J.Q., obviously more alert than I am to avoiding terminology which will frighten the natives (both overlords and underlings) of neoliberalism, has chosen a more careful term.

    Given that unemployment plus underemployment currently runs at about 14% IIRC and that Roy Morgan Research disputes Australia’s official unemployment rate of 5.7% and puts is at more like 11%, then it is clear that the current economy is highly inefficient in at least one respect. It underemploys on a large scale. Thus claims that avoiding a Job Guarantee and Basic Income Guarantee lead to an efficient economy in standard terms are clearly false. Labour underutilisation and fixed capital underutilisation are a factor of the current system.

    A move to a Job Guarantee (JG) and a Basic Income Guarantee (BIG) would simply formalise these realities and reduce both administrative overheads and “mendicant angst” at one stroke. Age pensions, invalid pensions, unemployment benefit, sole parent benefit, child payments etc. are in essence Basic Income Guarantees anyway, albeit poor paying ones which in many cases carry high administrative overheads and inflict onerous “proofs of eligibility” conditions on recipients.

    All welfare payments should be subsumed under a Basic Income Guarantee for persons aged 18 and over. The most logical way to implement this would be with a NIT (Negative Income Tax). Each person would have a tax threshold set. With income above that threshold they would start paying tax. With income below that thrshold they would incur a negative income tax which of course is a payment.

    There would never be any need to apply for a benefit of any type. Merely register or rather be registered automatically when a person turns 18. Every category of benefit goes out the window. The NIT exists for all and operates in one system. Work change events and life change events feed automatically through to change your NIT rate. The administrative simplification would be enormous.

    A JG would be necessary to give all those who wanted work some actual work to do. Despite the denigration of ordinary people and their implied reluctance to work, inherent in all neoliberal ideology, the fact is most people want to be useful and to do work which is to them interesting and fulfilling. A proportion of able people receiving income via the NIT, following a mass or staged transfer from the current welfare system, would want to perform socially recognised and payed work. A JG would accommodate these people again via a staged implementation. The JG would always soak up those people not employed by private enterprise and the need for this buffer would vary during the business cycle.

    A minimum wage for a full week’s work should also remain in force. A full week might be defined as 35 hours. A job via the JG would pay minimum wage rates too and be offered on a full or part-time basis as the applicant wishes.

    There would be no crowding out of private employment. The JG initiative employs only those who wish to work but cannot find work in private employment. There would be pressure on private employment to offer the minimum wage at least but that applies in any minimum wage system.

    JG recipients would also be under some performance pressure. Conditions of employment, including probation periods and performance evaluations would apply to the same degree as are applied to all public servants. Where persistent failure to meet work obligations occurs then after counselling etc., the person returns to essentially a NIT income with a waiting period of maybe 3 months (in the first instance) before being eligible again for the JG. The NIT income for a person with no other income would be at least as high as the current highest welfare payment which I believe is probably age pension. Single rates would always be paid. There would no testing for marital status or couple-hood.

    Overall, this system would be simple, effective, humane and completely economically sustainable given the high production of a modern, developed nation. There would be little or no reduction in overall incentive to work in the entire population. There would be an enormous increase in engagement and in the feeling of being worth something and valued and cared for by other people and society as a whole. The negative resistance engendered in people by the current blatantly coercive, exploitative and disrespectful (towards individuals) industrial relations system would largely disappear. Willing and happy people are vastly more productive, more inventive, more cooperative and more amenable. If we only we could lose the notion that people have to be whipped to work by the cruel economic goads of penury and exclusion snaking and snapping above their heads all the time.

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