by Jim Rose in macroeconomics, Milton Friedman, politics - Australia Tags: current account deficits, inflation, monetary policy

No one under 40 has an adult memory of inflation in Australia. They have forgotten what high inflation was like.

Those older than 40 have forgotten how inflation was tamed.

Edward Nelson’s paper ‘Monetary policy neglect and the Great Inflation in Canada, Australia, and New Zealand‘ is good on this. His paper trawls through the press reports of the 1970s onwards to document exactly what the views of the day were of the causes of inflation:

Policy-makers at least from 1971 viewed inflation as resulting from factors beyond their control, not as a consequence of their monetary policy decisions;

Policy-makers embraced non-monetary approaches against inflation in a manner that defied political classification; and

Highly interventionist strategies of compulsory wage and price controls was adopted by the traditionally more anti-interventionist of the major political parties;

The Governments and Reserve Bank of the 1970s and 1980s attributed the double-digit inflation of that time to a range of causes other than loose monetary policy.

1988 witnessed a major monetary policy tightening in Australia.

The tightening itself was motivated by balance-of-payments rather than inflation considerations. It was that old bogey, the current account deficit. The current account is the most pernicious statistic published.

The fall in inflation to 3% in 1991 transformed the views of policymakers and observers about the role of monetary policy in inflation control.

As late as 1990, the Governor of the Reserve Bank rejected central-bank inflation targeting as infeasible in Australia, and cited the need to use other tools such as wages policy.

When inflation fell below 3% in early 1991—clearly a response to the period of monetary restraint – I can assure you that none of the briefings to ministers at that time forecasted inflation to fall so rapidly.

Policy attitudes changed all through brute experience; no neo-liberal conspiracies here. Milton Friedman was still a swear word back then and the idea that inflation was a monetary phenomenon was still career limiting.

Gruen and Stevens (2000) record that in the 1990s, “the main insight of two centuries of monetary economics… that monetary policy ultimately determined inflation” convinced the authorities that non-monetary approaches to inflation control should be abandoned in favour of central-bank inflation targeting.

The current account did not change much as a result of the deep recession designed to bring it under control. The current account deficit as a major policy problem was quietly forgotten.