The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Sunday, March 20, 2011

Aussie central bank once again having kittens about inflation expectations

This is probably the most underappreciated, and least well covered issue in Aussie economics right now: whether inflation expectations can stay anchored within the RBA's target 2-3% pa CPI band. With the exception of the RBA and Ross Gittins, who is deliberately trying to talk it down (a commendable policy objective), I am pretty much the only one writing about it, if I can put it that bluntly. And let's be clear, the RBA has made an extraordinary number of references to the importance of Australian inflation expectations remaining anchored since the start of 2011 when the spectre of coordinated global inflation problems became increasingly apparent.

Take a few examples: this was a key assumption they highlighted in their forecasts in the last Statement on Monetary Policy; it was a key issue that Gov. Stevens and Phil Lowe belaboured in testimony to Parliament (going to the trouble to read out all the CPI expenditure classes that had fallen in Q4); the SMH's Ross Gittins has published a spate of articles trying to personally drag down price expectations (rehashing the RBA's Parliamentary testimony); it has popped up in Board Minutes; there was a full 30+ page Research Discussion Paper released on the subject by the RBA last week (see my post below reviewing it), which rather cutely claimed that there was nothing to--currently--worry about (the Melbourne Institute's survey of consumers, as opposed to the RBA's analysis of 'investors', suggests otherwise); and now we have a Bulletin article published on Friday that suggests this is one of the biggest challenges for monetary policy. But where are my market economist mates? Largely MIA. It's actually a pretty simple matter. If the RBA loses control over long-term inflation expectations, it can pretty much chuck the entire monetary policy framework out the window until it gets them once again anchored, which is bound to be a very difficult process. 

In this impressive RBA Bulletin article on global food prices, the authors argue:

"[A] potential concern if food prices continue to rise is that consumers may come to expect higher inflation on an ongoing basis and adjust their behaviour accordingly. This is more likely to be an issue in developing countries, where food makes up a larger share of households’ consumption basket...

[I]n the medium to long run, it is likely that food prices will remain at a relatively high level given ongoing strong demand. In fact, the OECD-FAO (2010) projects that most crop and livestock prices over the next 10 years (in real and nominal terms) will exceed the average levels of the
decade prior to the 2007/08 peaks, underpinned by an increasingly high-cost structure, strong demand from developing countries, continued expansion of biofuel production and slower growth in agricultural production.

While monetary policy cannot affect the long-term relative price of food, the challenge for central banks in these circumstances is to keep the general level of prices contained and inflation expectations well anchored."

The authors present some terrific analysis on global food price dynamics, which they claim, "are leading to higher headline consumer price inflation in many countries though, at this stage, core measures of inflation remain relatively contained." The latter contention about contained core inflation looks to be wrong based on their own anlaysis of East Asian data (see first chart), with cores rising back to pre GFC levels. Nonetheless, the paper is first-rate and well worth a read.