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Foreign Policy Analysis
Reserve Bank of Australia – Monetary Policy Framework

Reserve Bank of Australia – Monetary Policy Framework

If people come into the foyer of the Reserve
Bank, and they’re always welcome to do that here at Martin Place, you will see on the
wall on the right hand side there’s some letters etched into the black stone there, that are
from our Charter, those words are from 1945, they haven’t changed since, and they’re about
stability of the currency, the maintenance of full employment and the prosperity and
welfare of the Australian people. Now they’re very big, broad, fine sounding words, how
do we put that into practice? Well the way we do that is we have a medium term target
for inflation and we talk about holding CPI inflation to 2 to 3 per cent on average over
time. In other words, preserving the value of money and that’s very important, because
a stable money is really a foundation for economic prosperity more generally. If we
don’t have stable money then whatever else we do we won’t really be able to achieve broader
economic prosperity. That framework’s been in place since the early 1990s, we have hit
the target over that 20 year period, the average inflation rate’s pretty close to 2.5 per cent,
so we regard that as successful by the terms of the definition that we set ourselves and
I think that’s made a big contribution to economic stability more generally and I don’t
think it’s an accident that that period of fairly low predictable inflation has coincided
with pretty good sustained growth in the economy. The target is a medium term one, so there’s
a little bit of flexibility over the short term, and I think experience shows that in
trying to do economic policy and trying to control inflation there really isn’t an ability
to fine tune these things over very short periods of time, you have to take a more medium
term perspective. We’ve always thought that and I think experience shows that that’s the
right way to do it, and as I say we’ve managed to achieve that target fairly well over quite
a long period of time now. Sometimes things happen, economists refer
to these things as shocks which just means they’re events which are not forecastable
and not controllable. Things come along it might be a rise in global oil prices because
there’s military tension in the Middle East, it could be the celebrated banana price rise
because the crop’s been damaged by a cyclone, it could be some government policy that raises
or lowers the cost of medical care, so these things come along and they affect the measured
inflation rate over a short period, and we can’t stop that occurring, we can’t control
that, but the key thing is to have inflation come back to the target over time and the
policy decision is really about trying to configure the interest rate setting so that
we can be pretty sure that inflation will come back over time and one of the key things
that helps us do that is if people’s expectations about inflation in the future are well anchored
near the target, that actually feeds through to their behaviour, to the behaviour of wage
setting, to the behaviour of business and the way they set prices, if they behave consistently
with the target that actually helps us achieve it. So one of the things we watch is whether
those expectations are indeed well anchored or not and that helps us to work out what
response we might need when inflation starts to go off course. While historically we’ve had this board for
a very long time, since the early 1950s, it’s always been a board where the Governor is
the Chairman but we have a majority of outside people drawn from industry, from academia,
from sometimes other parts of society who bring a common sense perspective, they bring
their own commercial or academic experience and they apply a filter of the, I suppose
you could say, the educated, informed, reasonable person to the judgements that we on the inside
want to bring to the decision and for us to get the decision that we think is right we
have to convince them. And that’s as it should be. That’s a strong filter. I think our board,
although unusual amongst other boards, there are very few if any other central banks that
have this kind of a board, but in our country, for this kind of filter to be applied to the
decision process, I think adds to the credibility, to the legitimacy that the whole process has
in the eyes of ordinary people and that’s very important. So it’s worked quite well
for 60 years now.

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