THE CASE AGAINST AN INFLATION-LED RECOVERY
Stone the crows! Inflation is on the agenda.
Anybody who remembers the 1970s will recall inflation as awful – stealing savings, slowing growth and stopping budget discipline in state spending. According to Don Stammer:
Australia fared worse than other countries, with stagflation running from 1972 to 1984. Unemployment rose five-fold from trough to peak; a decade of inflation averaging 10.6 per cent a year cut savagely into the value of interest-bearing investments; and our shares fell more in inflation-adjusted terms than in any other share market crunch before or since.[i]
The easy explanation is that it was caused by the oil shocks but rising wages without commensurate productivity growth certainly did not help us, the US and Europeans.
But bankers with economies that may be breathing, but not so loudly that anybody will notice, are now suggesting that 4 per cent inflation is needed to kick start growth. As IMF economist Laurence Ball argues, “It is not clear what target is ideal, but four per cent is a reasonable guess, in part because the United States has lived comfortably with that inflation rate in the past. If central banks raised their inflation targets from two to four per cent, the economic benefits would exceed the costs.”[ii]
Ball argues that opposition to the idea is an example of central bankers fighting the last war:
The high inflation of the 1970s was a scarring experience that has dominated the thinking of central bankers since then. Before the crisis of 2008, the 1970s were considered the worst monetary-policy disaster since World War II. Policymakers believed that their most important job was to prevent another inflationary episode. … This mind-set has led policymakers to exaggerate the dangers of inflation.[iii]
At which the Crows just caw. Inflation as a sugar hit will not solve the problems of economies like Europe and Japan, economies that are stagnant or shrinking. Deflation is less cause than symptom of economies shackled by high wages, low productivity and government borrowing to fund unsustainable spending. It will take structural reform rather than inflation to kick start growth – “Stagnate, default, inflate — they all seem equally grim. The best solution for rich countries is to work off their debts through economic growth.”[iv] Strike that. Growth is less best than the only just way to reduce public debt – austerity is cruel, inflation and default are theft by other names.
And that growth must be without unsustainable stimuli. Yes, the Crows know we are not as indebted as the Europeans, the US and Japan – but to suggest that this means we can keep borrowing is like arguing that staggering drunks should keep drinking because they are in better shape than unconscious alcoholics.
Australia has already had cases where inflation reduced debt. Between 1945 and 1980, real interest rates in the advanced economies were negative for half the time and in our case the annual liquidation of debt that this delivered equalled 5 per cent or so of per annum GDP.[v]
There is another problem with inflation as policy prescription – once started it is hard to stop.
As Reserve Bank Governor Glen Stevens puts it:
The lesson of history is that if you allow a bit more inflation now, then pretty soon it is a bit more and a bit more after that”. [vi] And because inflation destroys real growth, “central banks would then want to get it back down. As we have seen in the past, this usually involves generating a recession.[vii]
The RBA has had a 2 per cent to 3 per cent inflation target for 21 years and it has served us well.[viii] As Glenn Stevens wrote a decade back:“It is apparent that inflation targeting has been associated not with reduced growth, but faster growth on average and less variable growth, as well as less variable prices.” And his argument still applies: “The conduct of monetary policy during the period of inflation targeting has exerted a stabilising influence on the economy over the course of the business cycle, and has allowed the supply-side improvements to find expression in higher levels of non-inflationary growth.”[ix]
Long may it stay that way. Using inflation to generate growth is an admission that an economy has atrophied and while that may apply in Europe it need not here.
There is another reason why we should not ever consider inflation as a means of reducing debt (apart from it being dishonest) – we would never get away with it.
Imagine what would happen to the dollar if real Australian interest rates were negative. And imagine what would happen to the cost of financing public debt – of which, when you include the states, we have a fair bit.
General net government debt is 12.3 per cent of GDP – which may not sound much compared to the rest of the OECD except that in 2007-2008 the net government sector was 2.7 per cent in surplus.[x] (Yes there was the GFC but the problem now is less emergency stimuli than funding recurrent health and welfare outlays.)
The IMF says our floating exchange rate “has served the country well by cushioning terms of trade shocks,” but the country does not need a sovereign risk crisis for the world to decide its currency is not safe.[xi]
Policy gun for hire – cases made and opeds written
[i] Don Stammer, “Stagflation risk: how worried should we be,” The Australian, July 20 2011
[ii] Laurence Ball, “The case for four per cent inflation,” April 2013 @ http://goo.gl/QXRTOB recovered on June 22
[iii] Laurence Ball, “The case for a long-run inflation target of four per cent,” IMF Working Paper, 14/92 June 2014 @ http://goo.gl/AcIwYY recovered on June 22
[iv] “In a hole: Stagnation, default or inflation await: The only way out is growth. The Economist, June 24
[v] Carmen M Reinhart and M Belen Sbrancia, “The liquidation of government debt,” NBER Working Paper 16893, March 2011 @ http://goo.gl/xPsRhe recovered on June 22
[vi] David Uren, “Glenn Stevens warns on house price speculation,” The Australian March 30
[vii] Buttonwood, “The inflation option,” The Economist, June 14 2011
[viii] Gary Shilson-Josling, “RBA’s inflation target 20 years old,” The Age, March 28 2013
[ix] Glenn Stevens, “Inflation targeting: a decade of Australian experience,” April 10 2003, Reserve Bank of Australia @ http://goo.gl/TVy2jP recovered on June 22
[x] Alan Payne, “Australia’s current debt position, December 2013” (Parliamentary Library) Flagpost December 222013 @ http://goo.gl/mj8oD9 recovered on June 22
[xi] International Monetary Fund, “IMF executive concludes consultation with Australia, February 12 2014 @ http://goo.gl/2qzM23 recovered on June 22