RBA Annual Conference – 1992 Discussion
1. Richard Snape
Glenn Stevens provides a thorough coverage of the history of inflation in Australia, the role of monetary policy, and the costs of reducing inflation. He rightly points out the strong connection which Australian inflation has with that of the outside world. But I think we take too easily the view that Australia has ‘always been an open economy’. It is true that we have been, and are, highly dependent on foreign commodity markets. But for most of the period covered by this study Australia was not particularly open as far as imports were concerned. For most of the fifties, across-the-board import quotas were tightened or slackened according to the state of our foreign reserves. During the sixties we had made-to-measure protection, as Max Corden termed it, and this continued into the early seventies. In 1973 the Whitlam Government cut all tariffs by 25 per cent, but in the following years imposed import quotas in some sensitive areas. The Fraser Government commissioned a number of reports with respect to trade policy but did little about it, so that over the 1970s average protection decreased but the dispersion increased. Only in the eighties has there been a major commitment by the government to open the import side significantly.
I am not suggesting that trade policy directly causes inflation. What I am suggesting is that more attention could be given to the interaction of trade, wage and monetary policies. Many of the ingredients were present in the fifties and sixties for wage increases to be granted readily in industries which were insulated from import competition by quotas or made-to-measure protection and to be passed on into prices. Such increases could also have been accommodated by monetary expansion to avoid unemployment, leading to a spiral. But this inflationary spiral did not occur. (It could be argued that protection-encouraged wage increases did occur in later years, for example in 1981, when the metal trades industries, accustomed to protection and to the central wage fixing system, yielded easily to pressures from the metal trades unions.) The interesting question which could be addressed, particularly in comparing Australia's experience in the 1950s and 1960s with that of many countries which had high protective barriers and inflation, or with Australia's own experience in later years, is why highly protective Australia did not have more inflation in those years.
I think we do not quite get enough of the feel of economic policy in those earlier decades – the days of Bretton Woods and the very great reluctance in Australia and in many other countries to countenance devaluation (or appreciation[1]) of the currency. The nominal exchange rate was a powerful anchor, and macro and wage policies were significantly tied to what the balance of payments allowed us to afford. In this context I would have liked to see more consideration of the relation between the terms of trade and the real exchange rate, particularly over the Bretton Woods period, together with discussion of the transmission linkages through domestic inflation.
With regard to the last decade or so, I think that rather more could be made of the cycle of exchange depreciation – inflation – (partially) indexed wages – exchange depreciation. Would domestic monetary policy have been easier if the government could have anticipated confidently that the real exchange rate could be depreciated by nominal depreciation? If so, we could have expected reduced capital inflow and external debt, a lower current account deficit, and higher employment. This of course brings us to the persistence of inflationary expectations (in sharp contrast to the early 1950s), and to whether the Accord has reduced or increased the rate of inflation, the real exchange rate, and the level of employment. The paper has a good bit to say on this and I am in sympathy with most of it, though I am less confident man Glenn about the inflation-reducing effects of the Accord in 1988/89. I think attention needs to be directed to the longer-term implications of wage-tax bargains, for example. Furthermore, are inflationary expectations low because depressed economic conditions are expected to continue, or have people revised downwards their expectations of the underlying inflation rate?
The paper refers to the changes in asset prices in Australia, though (unlike the discussion of inflation in general) it does not link this to asset price changes abroad.
While the paper limits itself in not considering the costs of inflation, it does examine the output costs of reducing inflation. There are logical problems with this position. Costs must be measured against an alternative scenario. The alternative scenario of the paper is a trend level of output along with whatever degree of inflation is being cured. But maintaining the level of inflation may itself be incompatible with the trend output level. I do not think one can adequately measure the costs of curing inflation unless one takes into account the costs of not curing it.
The paper considers several propositions which require the measurement of real labour costs and real labour income. These are areas of increasing difficulty. We are familiar with needing different deflators according to whether wages are a cost or an income and the problems of before- and after-tax income. But the difficulties are compounded by changes in the degree of legislated job security, with implications for the costs of employing workers. For the worker, there is presumably some additional income implied in job security. Then there is superannuation, which provides a current cost for employers but a future income for employees – another wedge between labour costs and labour income if one does not take future income adequately into account in measuring costs and benefits.
Finally, during the 1960s the inflation/unemployment balance (or the short-term Phillips curve) was remarkably good in Australia by OECD standards, in contrast to much of me next two decades. Why was the Australian macro performance so good? Why didn't we move back to our earlier success after the disturbances of the first half of the 1970s?
References
Coombs, H.C. (1981), Trial Balance: Issues of My Working Life, Macmillan, Melbourne.
2. General Discussion
The general discussion of Stevens' paper focused mainly on three issues:
- the reasons for the unusually sharp fall in inflation expectations in the disinflation of the late 1980s and early 1990s;
- possible explanations for why it appears more costly to reduce Australian inflation now, compared to the 1950s and 1960s; and
- the links between money and inflation in Australia.
With regard to inflation expectations, it was noted that they declined only slightly in the 1982–83 recession. Some participants argued that the main difference in the current deflation was the marked collapse of asset prices. Others suggested that there was now a much greater acceptance of the view that Australia was part of the world economy, and mat the associated need to be more competitive has played a role. Some speakers emphasised the role of the apparent greater resolve by the authorities to pursue low-inflation monetary policy. Without such resolve, the recession would have only a temporary impact on inflation expectations.
Table 3 of Stevens' paper generated considerable discussion concerning the increased difficulty of reducing inflation in recent decades. The average trough of inflation over the 1952–62 period was 0.3 per cent, compared with 5.1 per cent in the 1974–92 period. A range of views were offered on this subject. Some participants emphasised changes in community attitudes. A change of attitude was argued to have occurred in the 1970s, with the acceptance of Keynesian full employment policies and the emergence of the time inconsistency problem. Others emphasised the relaxation of the balance of payments constraints, following the expansion of the United States in the early 1970s and the breakdown of the Bretton Woods system. The balance of payments constraint was thought to have tied down expectations in the 1950s and 1960s, and implied that ‘capacity to pay’ was an important consideration in wage negotiations. With a fixed exchange rate system increases in nominal wages could not be accommodated by monetary policy. However, while the average inflation trough was higher overall in the 1974–92 period, it did progressively decline in the 1974–78, 1982–84 and 1990–92 disinflations. This was thought by some to reflect progressively more flexible wage setting arrangements.
With regard to the importance of monetary aggregates, a number of speakers questioned the link between M3 and inflation. Some argued that M1 or currency would be a more appropriate variable. However, most participants accepted that the relationship between monetary aggregates and nominal income deteriorated in Australia during the 1980s.
Footnote
The reluctance to appreciate in 1950 was with politicians rather than the Central Bank. The then Governor of the Central Bank, H.C. Coombs, writes that in May 1950 he advised the Treasurer ‘that to prevent Australian prices rising dangerously it would be necessary to limit public development works, to budget for a substantial surplus, to free interest rates and to tighten the supply of bank loans, and to increase the supply of imported goods by reductions in the protective tariff, by dollar borrowing and by an appreciation of the Australian pound.’ (Coombs, (1981), p.149) [1]