School of Economics and Finance

1
Policy Discussion Meetings
Paul Frijters and Joseph Jeisman

• Introduction to series by Paul Frijters (5
  minutes)
• Inflation targeting via interest rates, by Joseph
  Jeisman (15 minutes)
• This policy makes no sense by PF (10 min)
• It does by special guest Uwe Dulleck (10 Minutes)
• Group Discussion

2
Introduction to series
House notices

• Once every 2 weeks on a Thursday.
• Attendance roll for honours students.
• Interruptions and arguments from students warmly
  invited. Non-presenting staff are asked to keep
  quiet until the last 20 minutes.
• Were developing a website and a blog where
  students can download basic slides and argue for
  specific topics.TBA.

3
Background

• This is a revamp of an earlier discussion group
  by the school, On steroids.
• Part of a QUT wide drive towards research
  excellence. These meetings represent a major
  commitment from the school, are part of the new
  econometrics centre, and if things work out,
  youll get a better research training at this
  school than anywhere in Oz.
• Preliminary Team Paul Frijters and Joseph
  Jeisman (main organisers), Stan Hurn, Michael
  Drew, Adrian Pagan.
• Comes from the recognition that research at
  postgrad level in Economics and Finance is a big
  step up from an undergraduate degree and requires
  major time investments.
• These meetings are an attempt to instil an
  academic attitude and acquaint those interested
  with a sense of the breadth and depth of policy
  relevant issues in economics and finance as well
  as a glimpse of the research frontier.

4
Timing
At the end of 2006 Functioning reading groups
and workshops
5
Does Inflation Targeting Really Work?

• (and if so, how does it work?)

by Joseph Jeisman
6
Short History Lesson

• Numerical inflation target first articulated to
  public in 1993
• Formalised in 1996
• Current policy Aim for inflation to be between
  2-3 over medium term short term deviations
  from this band dont necessarily represent
  failure.

7
Some inside knowledge

• Central banks in most OECD countries now almost
  exclusively use only interest rate as a
  responsive monetary policy.
• The rule is basically if inflation looks like
  heading above 3 percent, increase interest rates.
  If it heads below 2 percent, decrease them.
• Policy discussion in the RBA involves crawling
  over data (lead indicators of inflation) and
  using low-brow argumentation. The deciding board
  has 9 members. 1 Economist and the rest
  non-experts. Salient notes one of our team
  members has been that economist econometrics
  deemed necessary for jobs at the RBA.

8
Markets follow the Central Bank
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10
The Verdict

• Ostensibly, everything appears to have gone
  pretty well since 1993.
• Inflation is low and relatively stable, upward
  pressure is combated by small rises in cash rate,
  which lower real GDP growth for a while, but
  relieves the inflationary pressure.
• So what is the problem?

11
Possible arguments for the prosecution (Paul)

• What drives monetary policy is still a very
  contentious issue. Some of the conventional
  explanations we are taught eg interest rate
  channel (in which an increase in the cash rate
  leads to reduced investment and consumption on
  consumer durables) hasnt received a whole heap
  of empirical support. If we dont know what is
  driving the success of inflation targeting how do
  we know that we are not just benefiting from a
  charmed set of circumstances? At the very least,
  we need to know how it works in order to know how
  to respond to a significant shock.
• Perhaps inflation targeting is only good for
  promoting solid (but not great) growth (see
  table)
• Is any inflation really a good thing? Should we
  be aiming for zero inflation?
• With small open economies and all goods traded,
  interest rate policy should be entirely
  ineffective central bank rates are then cheap
  talk.

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14
Possible arguments for the defence (Uwe)

• If it aint broke dont fix it. Seems to be
  working very well even if we dont fully
  understand it.
• A myriad of explanations of the transmission of
  monetary policy have been developed, many which
  complement each other and may explain some of the
  seeming deficiencies of the traditional
  explanations. For example, transmission may occur
  via exchange rate markets or markets for credit.
• Even if inflation targeting does promote solid
  growth rather than spectacular growth if it
  smooths out the downs as well as ups then that is
  probably a good thing.
• There are also arguments advocating the
  usefulness of small positive inflation.
• Interest rate policy should work for things that
  are either non-tradeable over countries or only
  so at high costs. Property is a prime example.

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