Conference – 1992 Discussion

In the discussion following Corden's perspective on the Conference, the desirability of some low-inflation objective was broadly accepted. Some preferred an explicit inflation target, while others supported a nominal income target or some looser commitment to low inflation. Against this background, participants focused mainly on:

  1. the extent to which policies could ignore the activity and unemployment consequences of achieving low inflation; and
  2. how the conduct of monetary policy might contribute to improving this trade off.

With regard to the first topic, there was considerable discussion of time inconsistency problems that might emerge if unemployment issues were ignored. These become extreme if hysteresis effects are important. Mounting unemployment, particularly of the long-term variety, constitutes an eventual obstacle to the continued success of disinflationary policy, and hostility to so-called ‘rational’ monetary policies could emerge. This could result in time inconsistency problems, as authorities were forced to reneg temporarily on their inflation target to reduce unemployment. Some participants suggested that this issue underlined the need to adopt other policies (other than monetary policy) to tackle the unemployment problem. This would help to ensure that low-inflation policies remained sustainable in the longer run. Some speakers suggested that hysteresis problems could be present in the Australian economy, even though these are difficult to detect in wage equations because of the presence of the Accord. If this were so, the need for improving the functioning of labour markets would be even more urgent. Policies to increase the flexibility of real wages for some sections of the labour force were emphasised in this context.

The discussion of the conduct of monetary policy covered a wide range of issues. Given the complexity of the interaction between economic activity and prices, some speakers stressed that focussing on inflation alone is not desirable. The rules versus discretion debate was not clear cut, and could never be. Nevertheless, it was thought that there is a clear need for more thinking about the operating strategies of central banks in most OECD countries. If forecast inflation using relevant leading indicators exceeds the low-inflation objective, then short-term interest rates should be raised. But it has proven very difficult in practice to decide how much interest rate adjustment is desirable in any given circumstance. There was a view that the monetary authorities in some overseas countries were too slow to act during the recent deflation. They did not move interest rates initially as far as was desirable, and the long drawn out nature of the tightening and subsequent easing worsened the trade-off between activity and inflation. This contrasted with the relative success of the Volcker disinflation.

Some speakers felt that pursuing a low-inflation target by adjusting interest rates pre-emptively in response to forecasts of inflation based on leading indicators risked inducing business cycles. This could arise if there were very large errors in forecasting activity and inflation. If this were so, the case for using an intermediate target such as the exchange rate or the money supply would be increased. A few participants went as far as to suggest that the absence of an obvious single currency link for the Australian dollar did not undermine this possibility, because the trade-weighted exchange rate could be pegged. However, most participants rejected the idea of a pegged exchange rate for Australia, given the importance of major shifts in the terms of trade. This would continually undermine the credibility of an exchange rate target. Some felt that Australia was fortunate to have a flexible exchange rate.