Inflation must follow

The world is filled with irony and idiocies aplenty. For how many year did I try to fight off inflation targeting while I was Chief Economist at ACCI with the many reasons for my objection centring on that fact that we did not at the time live in an inflationary environment. Especially with budgets in surplus and wages growth under control, it seemed to me that the ingredients for a serious inflation were just not there. 

Now we find the IMF suddenly thinking that perhaps inflation targeting isn’t such a good idea after all, that allowing a bit more room for prices to grow might not be such a bad thing. 

The front page story on The Australian (February 15) carries the following message: 

The International Monetary Fund has called for the overthrow of inflation targeting as the central goal of economic management, and urged that inflation be allowed to rise to 4 per cent to give governments a better ability to manage downturns.

The article then continues with a comment on the IMF’s views which I find simply astounding. Anyone who remembers the recession we had to have, which was brought on by murderously high interest rates to kill off the perceived inflationary threat of a booming economy, will see just how bizarre the following is: 

In a radical paper calling for far-reaching economic reform, the fund says too much reliance has been placed on interest rates to control the economy, and budget spending and direct regulation of banks should play a greater role. 

I couldn’t say it better myself. In fact, the theory behind inflation targeting, to the extent that there actually is a theory, was that recessions were only caused by inflation. Avoid inflation and you avoid recession. We now have the deepest recession since the Great Depression and it came upon us without the slightest hint of inflation anywhere to be seen. 

That inflation is not the only cause of recession ought to have been known to one and all but for those whose history does not go back beyond the 1970s, it might have seemed plausible. There is no doubt that the 1970s were a period of rapid inflation coupled with high unemployment. 

But it wasn’t the inflation that caused the unemployment, it was the combination of massively increased public spending, wage explosions and huge increases in the price of oil. It was these that caused both unemployment and inflation to move beyond control and then continue for years on end. 

So now we find the IMF arguing that given the downturns we are all in, and the inflationary potential that the various stimulus packages have led to, that the answer is more inflation. The Australian’s story is not wrong about the likely reaction: 

The IMF’s recommendations up-end 15 years of economic orthodoxy, and will spark fierce debate among policymakers and central bankers around the world. 

I have never been a fan of inflation targeting but inflation is about as bad an economic disease as one can find. Combining the useless unproductive public spending we have inflicted on ourselves with a loosening of our inflationary restraints will seriously undermine our future rates of growth and reduce our living standards for years to come. 

It was always an open question whether Kevin Rudd would become the new Whitlam and be remembered in exactly the same way. Follow the IMF advice on this one will make it a certainty.