May 24, 2016 2:00pm by David Farrar

Brash on inflation targeting

The first central banker to introduce inflation targeting to the world, the Reserve Bank of New Zealand’s Don Brash, says it is still relevant and today’s low inflation problem is probably something that will fade away.

“If you say ‘we don’t like inflation targeting’ what do you propose instead? It’s not at all clear what the alternative is,” the former governor told Fairfax Media.

“You’ve only got one instrument you can only really hit one target effectively. What target is it? Logically it should be some rate of inflation, I would have thought. Is inflation targeting desirable? Absolutely in my view. Is it sufficient? Probably not.”

Dr Brash saw parallels with the Gulf War when oil caused a period of high measured inflation and “most central banks said you’ve got to ignore that”.

“We know that monetary policy has only a short-term effect on employment and on real growth.”

Some used to argue that low inflation caused high unemployment but there has been a huge amount of empirical evidence to show this is not the case.

New Zealand targets annual inflation of between 1 and 3 per cent over the medium term, guided by a future midpoint of 2 per cent, versus the preference for 2 to 3 per cent price growth in Australia.

Wellington has shown a willingness to review its inflation target since its seeding in 1988. The concept was originally embraced as a way to protect the integrity of monetary policy setting from political meddling around election cycles.

Former prime minister Sir Rob Muldoon “used monetary policy in a very, very cynical political fashion”, Dr Brash recalls. The RBNZ was asked to find a way of “Muldoon proofing monetary policy” and that evolved into New Zealand’s policy targets agreement. It aimed for zero to 2 per cent growth, which is the same thing as price stability plus or minus 1 per cent.

I think we should still have this as the target range. I prefer 1% inflation to 2% inflation.