Ever been the victim of a poorly specified target?
I used to be, for years, when I had to change trains. The timetable indicated that the next one would arrive a few minutes after the first. And it nearly always did, except that it often sped past without stopping. It had a target to meet.
Hospitals do it with waiting lists. Told to get them down, they find excuses to knock people of the listf, even if they are still waiting. Chief executives do it with share prices. Incentivised to get them up, they bring forward income, skimp on actually looking after their customers, and act surprised when things collapse. Dick Smith is an obvious recent example. The target - share price - has ended up driving the enterprise rather than what the target sought to achieve.
And the Reserve Bank might be another.
Until the early 1990s it didn't really have a target, just a feel-good vibe in its Act that directed it to work "to the greatest advantage of the people of Australia". To flesh things out, the Act says it has to work towards the stability of the currency, the maintenance of full employment and economic prosperity.
But too many targets means no target at all, so in the early 1990s, as part of a movement that began in New Zealand, our Reserve Bank joined a number of its international cousins and zeroed in on just one numerical target: inflation. Changes in prices as measured by the consumer price index had to be kept to between 2 and 3 per cent per annum on average over time.
When Glenn Stevens took over as governor in 2006 he formalised the target in a written contract or "statement on the conduct of monetary policy" signed by him and the treasurer Peter Costello.
It justified giving pre-eminence to what had previously been just one of several objectives by describing price stability as a "crucial precondition for sustained growth in economic activity and employment".
The words "over time" allowed it to delay adjusting rates to meet the target if it thought that, say, employment really mattered more. But by being placed at the centre of the document and being the only part of it that had a number attached to it, inflation came to be seen as the bank's number one target, in the same way that running on time came to be seen as the number one role of the railways, at least until commuters complained.
It has stayed the number one target because most of the time it has done the job pretty well. If inflation was climbing it usually meant that the economy was overheating and could do with higher interest rates. If it was falling, it usually meant employment was weak and would benefit from lower interest rates.
But not always.
When prices jumped on the introduction of the goods and services tax and then on the introduction of the carbon tax it meant no such thing. The Reserve Bank suspended its inflation target saying it would "look through" recorded inflation to adjust rates only in accordance with what it thought would have happened without the disturbance. It's done the same for changes in the cost of health insurance and the price of bananas. It has maintained fidelity to its target by suspending it, which gives a pretty good indication there's something wrong with it.
There've been five new contracts since the first (usually after each election or when the governor's term has been extended) and each has put inflation first. There's about to be a sixth, to coincide with the appointment of Stevens' successor, Philip Lowe. This time there's a push for something better.
Senate linchpin Nick Xenophon is the front person for a bevy of exceptionally bright economists including Warwick McKibbin, an internationally renowned member of the Reserve Bank board, and Danny Price of Frontier Economics in Melbourne, who want what bigwigs in the US such as former treasury secretary Larry Summers and former Obama adviser Christina Romer want – a target that explicitly acknowledges economic growth.
The best candidate is so-called nominal GDP, which is real growth plus inflation. The bull's-eye would be 5.5 per cent, which is about the long-run average. If real growth was weak even though inflation wasn't, the Reserve Bank would cut interest rates anyway in order to get either it or inflation up. It'd be a single number, as is the inflation target, but it would serve dual purposes.
Right now it would mean even lower official interest rates, perhaps even negative as happens overseas, in order to get businesses employing and consumers spending. During unsustainable booms it would mean higher interest rates than an inflation target alone would produce. As with the inflation target, it would be a goal to be achieved over time, giving the bank wriggle room to ensure the adjustments aren't too dramatic.
All Xenophon wants is a Senate inquiry to at least talk about it before the governor and the treasurer sign on the dotted line. A government genuinely committed to governance would grasp the opportunity.In The Age and Sydney Morning Herald