Glynn’s take: Tinkering with RBA’s inflation target now courts disaster

Day one of the Australian government’s review into the workings of the Reserve Bank of Australia, the first since the 1990s, has produced some comments in Canberra that should worry onlookers in financial markets and the public at large.

While RBA Gov. Philip Lowe was delivering a speech in Melbourne on inflation and parading charts showing the enormity of the inflation surge now playing out across major economies, Treasurer Jim Chalmers was in Canberra announcing the review, telling reporters he is open to a discussion about changing the 2% to 3% inflation target.

“I haven’t yet had proposed to me a version of an inflation targeting regime which is better than the one we have, but I’ve got an open mind to that changing. I’ve got an open mind to other perspectives,” he told reporters.

“And I think it is important that we give the panellists [leading the review] the capacity to look at that properly,” he said. “I suspect that [the inflation target] will be a big part of the considerations.” There is a problem here.

Tinkering with the target now, or even suggesting it could be changed, runs the risk of undermining the RBA’s ability to contain inflation expectations. If consumer and business expectations about price growth break their mooring in the months ahead, the coming peak in interest rates will be higher than otherwise would have been the case.

Government bond markets and the Australian dollar will be exposed to heightened uncertainty if the discussion around the review drifts toward changing, or even eliminating, the inflation target.

RBA governor Philip Lowe watches the address by Treasurer Jim Chalmers at The Australian Strategic Business Forum. Picture: Arsineh Houspian

Economists agree that remaining true to the current target over the past three decades has helped Australia moderate economic cycles and avoid recessions.

The inflation target is the anchor that holds in place everything involving monetary policy, and to put it up for discussion when Australia’s inflation is at its fastest pace in 30 years risks deepening the crisis.

Raising the inflation target would remove some of the pressure on the RBA to raise interest rates, but it would also undermine the concept of having a fixed and understood target. Equally, lowering the inflation target would invite in damaging disinflation at points in the economic cycle.

The current target has worked well, and there is little reason to change. What good is an inflation target if it is adjusted up or down at regular intervals to suit the whims of the day. The answer is none.

As Australia’s inflation surges in a manner few modern-day economic policy makers will have experienced before, Mr. Chalmers has chosen the exact wrong moment to begin a discussion about the target.

Fast forward to the end of this year, when the official cash rate is possibly above 3.0% and inflation has jumped above 7%. Tossing around different models for the inflation target at that moment would be irresponsible.

Those leading the review should declare early in their investigations that there is no interest in changing the target. That would remove the biggest fear for markets and allow the process of the review to move forward in relative quiet.

One of the big criticisms of the review is its apparent lack of purpose. Its terms of reference are so broad and wide-ranging, there is no real focus. Within that void, there could come bad outcomes, proposed almost for the sake of it.

An RBA review is good public policy, just not now.

The Wall Street Journal