And that someone is in far-away Australia, a country that has avoided recession for a quarter century. Things started going wrong for the past few years, when it ignored its NGDP level target and started worrying about home prices.
Read this: The new RBA governor should target [nominal] growth, not inflation:
If you had told Australians 10 years ago that official interest rates would fall to 1.5 per cent, many would have jumped for joy.
Aside from homeowners, Australians are not feeling much joy these days. This is despite the lowest interest rates in 70 years, low inflation, economic growth close to normal and the unemployment rate – though not ideal – still lower than it was during the Sydney Olympics.
So why are we feeling so miserable? The reason is that most Australians’ incomes are going nowhere.
Wages are growing at recessionary levels, profits for small and medium-sized businesses are flat and the budget deficit constrains government spending.
Overall, Australia’s “nominal” growth rate – the growth in actual money in our pockets – has fallen from 7 per cent per annum in the decade before the GFC to only 2 per cent today.
A large part of it is also due to the out-of-date inflation target that the Reserve Bank of Australia has been tasked with hitting.
A better option would be for the RBA to target a reasonable rate of growth in Australia’s nominal GDP.
In other words, we should replace the RBA’s existing inflation target with a nominal GDP target.
Stronger growth in nominal GDP would provide workers and businesses with greater means to pay their debts, hire more staff and invest in new plant and equipment.
Why nominal GDP targeting for the RBA is worth a debate at least
by Nick Xenophon
So, Jacob Greber says that my joint proposal (along with Danny Price from Frontier Economics) for the Reserve Bank to adopt nominal GDP targeting instead of the inflation is a “stupid idea”.
What would be really stupid is if we ignored the alarming drop in our nominal income growth, and the fact the RBA seems to be hamstrung with the current orthodoxy.
Mr Greber suggests that an NGDP target of 5 per cent a year would have led to interest rates being “catastrophically high” during the coal and iron ore price boom of 2009 to 2012. But average NGDP growth over those four years was only 4.7 per cent. This suggests that, if anything, interest rates would have been lower on average across that period than they actually were.
A 5 per cent NGDP target would certainly mean lower interest rates today. But that is exactly what the economy needs. Lower rates would boost consumer and business spending, lower the dollar – helping exports – and increase tax revenues and employment.
Granted, lower rates would likely mean higher property prices – but only in the absence of other policy levers and measures that could be implemented. Even so, outside of Sydney and Melbourne, property prices have not risen particularly quickly in recent years. Across all eight capital cities, prices have grown at an average of 5 per cent a year over the past five years – hardly runaway growth.
In any case, a single policy instrument (such as interest rates) can only sensibly be used to target a single objective, whether that is NGDP or inflation. Glenn Stevens recently commented that despite lower interest rates, macro-prudential policies have successfully headed-off housing market risks. Mr Stevens also identified the best solution to Australia’s relatively high house prices – more housing supply – and observed that more supply is on its way.
It is true that Australia is different to the United States and Europe because our NGDP growth is more strongly influenced by commodity price changes. But is that a problem? An NGDP target of 5 per cent to 6 per cent a year would have meant higher interest rates and slower economic growth in the boom years prior to the global financial crisis. But that may well have been a good thing. More importantly, the commodity price bust we have experienced since 2011 would have been a lot easier to deal with under an NGDP target.
Finally, it’s simply untrue that an NGDP target would need to be continually adjusted for changes in population growth or productivity. An NGDP target would allow positive or negative supply shocks to be absorbed through changes in the rate of inflation rather than through changes in revenues, wages and incomes. Ultimately, these are the variables that are important for macroeconomic stability, not some abstract measure of inflation. How does someone who starts a business – taking out a loan and hiring staff – in expectation of 7 per cent a year growth in nominal spending deal with a sudden drop in spending to 2 per cent? Not well, I reckon.
Incidentally, inflation-targeting involves its own compromises. In particular, it requires the central bank to take a view on how far the economy is from its potential “full employment” level of output. But no one really knows what potential output is, or what unemployment rate corresponds to full employment. The United States Federal Reserve has been facing this very issue over the past few years and its views on what constitutes full employment have changed significantly over that time.
Of course, as I have said, NGDP targeting is no silver bullet. But it can help smooth our transition away from mining with less human cost than we are inflicting on our citizens today.
Nick Xenophon, Senator for South Australia
Becky, thanks for posting this.