In previous posts, I pointed out that Australia had avoided recession for 26 years by keeping NGDP growing at a decent clip. Some commenters suggested that it wasn't monetary policy; rather, Australia was a "lucky country" benefiting from a mining boom. That theory made no sense, because if your economy depends on highly volatile commodity exports, then you should have a more unstable business cycle than countries with large and highly diversified economies. In any case, recent data completely blows that theory out of the water:
Stephen Kirchner directed me to a very interesting article discussing the views of Bill McKibbin, who used to be a governor at the Reserve Bank of Australia:
Former Reserve Bank of Australia board member Warwick McKibbin says the world's central banks should switch to a system of using official interest rates to target nominal income growth to ensure huge household and government debt burdens are unwound safely...
"Inflation has been a good intermediate step because it tied down price expectations and gave people confidence that central banks wouldn't deflate away their assets," he will tell a major economics conference in Sydney on Wednesday.
"That's important when you have high inflation," as was the case in the 1970s, 1980s and early 1990s.
"But you can still have the same credibility if you do have a very explicit income target, which is really growth plus inflation," he says.
In Australia, he suggests, that would mean the Reserve Bank would attempt to keep nominal gross domestic product growth - which is essentially a measure of how much the economy is paid for the goods and services it produces - at about 6 per cent.
Australia has a population growth rate of 1.4%, and so there is no question that its NGDP growth rate should be higher than in the US rate (population growth = 0.7%) and much higher than in Japan (falling population). Nonetheless, I think 6% is a bit high - I'd recommend something closer to 5% for Australia. On the other hand, even 6% would be far better than the sort of policy enacted by the Fed, ECB and BOJ since 2008.
Professor McKibbin, from the Australian National University's Crawford School, acknowledges that in practice the Reserve Bank already pursues an "ambiguous nominal" income growth target because the formal 2-3 per cent inflation target is only applied "over the cycle"
This supports the claim of various market monetarists, who have suggested that Australia was a covert NGDP level targeter during the Great Recession.
I've argued that the greatest advantage of NGDP targeting for countries like Japan is that it can reduce the burden of public debt. McKibbin makes a similar argument:
"What will matter over coming decades will be nominal income growth because the sustainability of high public and private debt-to-income ratios will need higher nominal income growth than in the past.
Interestingly, even a 6% target would seem to call for monetary tightening right now:
According to his proposed income targeting scheme today's Reserve Bank cash rate of 1.5 per cent is probably too low given nominal GDP rose in the first quarter by 2.3 per cent from the previous three months, and by 7.7 per cent from a year earlier. "Right now the central bank has probably got loose monetary policy by nominal income standards and you'd expect they'd be tightening policy according to this rule because nominal income growth is rising quite quickly."
Wait, that can't be right. My critics say Australia was just a lucky country benefiting from a mining boom. It can't possibly be doing well now that mining investment is collapsing. Or am I missing something?
The Economist describes how smart countries handle re-allocation out of declining sectors:
As the mining boom petered out, the Reserve Bank cut its benchmark "cash" rate from 4.75% in 2011 to 1.5%. The Australian dollar fell steeply (it is now worth $0.76, compared with a peak of $1.10 six years ago). The cheaper currency and lower interest rates have allowed the older and more populous states of New South Wales and Victoria to keep the economy bustling. Property developers are building more houses, farmers are exporting more food, and foreigners (both students and tourists) are paying more visits: Australia welcomed 1.2m Chinese last year, a record.
Re-allocation doesn't cause recessions, tight money does.
In the past, I've argued that Australia might want to target total compensation of employees rather than NGDP. That's because changes in the price of mineral exports can cause big swings in NGDP, without having much impact on the labor market. Over the past 12 months, employee compensation in Australia rose by only 1.4%, far below the 7.7% rise in NGDP. You don't see those sorts of discrepancies in the US. So maybe Australia doesn't need tighter money.
PS. David Beckworth has a new policy paper on NGDP and the knowledge problem facing policymakers. As usual, David includes some nice graphics.