The RBA Review Should Consider Nominal GDP Targeting
The government has released the terms of reference for the independent review of the RBA. They are pretty comprehensive, covering:
- The RBA’s objectives, as outlined in the Reserve Bank Act (1959) and in the Statement on the Conduct of Monetary Policy, including the continued appropriateness of the inflation targeting framework.
- The interaction of monetary policy with fiscal and macroprudential policy, including during crises and when monetary policy space is limited.
- Its performance in meeting its objectives, including its choice of policy tools, policy implementation, policy communication, and how trade‑offs between different objectives have been managed.
- Its governance (including Board structure, experiences and expertise, composition and the appointments process) and accountability arrangements.
- Its culture, management and recruitment processes.
I’m very happy to see the review will specifically be looking into the appropriateness of the RBA’s inflation targeting framework.
The government appears very committed to inflation targeting, and this is the ‘default’ approach across most of the developed world. However, I hope the review board consider other options, like Nominal GDP Targeting (NGDPT).
NGDPT offers several advantages over inflation rate targeting that make it a superior tool for central banks:
- Targets price levels rather than the rate of change in price levels.
- Increases the relative importance of output or employment in the economy when setting monetary policy.
- It responds to shocks in both aggregate demand and aggregate supply.
- It encourages sounds fiscal policy and discourages unsound policy by offsetting changes in fiscal policy.
- It dispenses with the zero-lower-bound and makes negative rates more palatable.
NGDPT would deal with several of the terms of reference for the review. In models, NGDPT would have dealt better with the recent shocks to the economy (like the GFC and COVID) than inflation targeting did.