I recently saw an article asking this question and was left with this answer.
Probably not, but we could ask better questions.
Brian Redican (chief economist at NSW Treasury Corporation, previously at Macquarie Bank, previously at The Reserve Bank of Australia) has said that the
“central banks don’t have as much control over inflation as some people imagine.”
https://www.abc.net.au/news/2024-06-16/brian-redican-luci-ellis-different-ways-to-dampen-inflation/103980488
Intuitively, there is no reason to believe the RBA has any significant influence on price movements: a) the official cash rate (OCR) is determined by a committee, whereas b) prices are determined by thousands of businesses in a market economy making thousands of decisions about thousands of prices, c) domestic prices of are often determined by rest-of-world events, and d) there are (legitimate) institutional changes to prices.
An example of (b) are increasing insurance costs responding to the real costs for houses built on floodplains when the severity of flood events have increased. See these two articles.
https://www.abc.net.au/news/2023-02-09/new-south-wales-floods-lismore-insurance-crisis-730/101944920.
An example of (c) is the fact that Australian retail prices of diesel and petrol follow closely the Singapore market. The size and proximity of the Singapore market combined with inelastic demand (not affected by price changes) from Australian consumers and world events significantly influences prices. Domestic gas prices increased as Europe replaced russian supplies, not because demand or production costs increased.
Examples of (d) are the regular indexing of excise rates to the CPI and annual revisions to education costs and health insurance, annual changes to new car prices as manufacturers introduce upgrades and new models.
Mr Redican argues that the best the RBA can do is keep “inflation expectations anchored.” Inflation expectations are more important than the ability of central banks to actually influence prices.
In practice, inflation expectations are either, a) the last published quarter on same quarter last year change in the CPI assumed to continue into the future, ignoring any downward trends, or b) a forecast usually proved wrong.
Dr Lowe said in a speech at the AFR Business Summit on Wednesday 9 March 2022:
“The war in Ukraine and the sanctions against Russia have created a new supply shock that is pushing prices up, especially for commodities,”.
“This new supply shock will extend the period of inflation being above central banks’ targets.
“This runs the risk that the low-inflation psychology that has characterised many advanced economies over the past two decades starts to shift.
“If so, the higher inflation would be more persistent and broad-based, and require a larger monetary policy response.”
https://www.abc.net.au/news/2022-03-09/philip-lowe-warns-russia-ukraine-war-will-send-cause-inflation/100894240
In plain language, ‘If the RBA thinks everybody expects inflation the OCR will go up a lot.’
Dr Lowe doesn’t seem to notice that inflation over the past two decades might have been low due to a dearth of ‘special military operations’ and other shocks. [You can research the ‘great moderation’ for more.]
Mr Redican suggests governments could ensure “inflation propagation mechanisms dampen, rather than amplify, inflationary impulses,” and refers to a suggestion by Dr Luci Ellis that (for example) excise could be indexed by 2.5 per cent, as well as indexing tax brackets by 2.5 per cent.
The argument is that indexing selected values by 2.5 per cent will keep inflation ‘anchored’ and be less likely to lead to higher rates of inflation.
[For more about income tax brackets, have a look at: https://www.pbo.gov.au/about-budgets/budget-insights/budget-explainers/bracket-creep-and-its-fiscal-impact.]
Absent is any meaningful discussion of how the RBA should respond to supply side shocks and business decisions (such as insurance premiums for flood prone housing). Making mortgage holders give more money to banks can not have any effect on these sources of price changes.
There is no theoretical basis for a 2.5 per cent inflation target. The target is not an evidence-based nor theory-based objective. If you can keep inflation in a one per cent range, why not keep inflation between zero and one per cent?
Some central banks use an inflation target of less than 3 per cent – less ideology and more concern about rates of price increases over 3 per cent.
Since June quarter 1983 to March quarter 2024 (including the high inflation of the 1980s and the COVID pandemic) the CPI Trimmed Mean (the RBA preferred measure of inflation) has been in the 2-3 per cent range 43% of the time – worse than tossing a coin. This 43% success rate supports the conclusion that the RBA has no significant influence over changes in prices.
Between June quarter 1992 and June quarter 2021, (after the high inflation of the 1980s and before the pandemic disruptions), the annual average change in the trimmed mean was 2.4 per cent. Arguing for selected prices to be indexing by 2.5 per cent seems redundant.
To answer the question, “Can we dampen inflation?” with, “Yes, if we anchor it at 2.5 per cent,” lacks intellectual rigour and reveals an ideological bias.
If the real focus of RBA policy is on expectations of price changes, and not the actual price changes, an improved policy would be to ignore price changes the RBA has no influence over and therefore has no reason to try and influence with changes to the OCR.
Using the CPI to index prices included in the CPI is arguably valid if the item makes a very low to insignificant contribution to the change in the CPI. Price changes that reflect market realities (e.g., insurance premiums above) aren’t really inflation?
The RBA needs to recognise higher interest rates have no effect on supply side causes, or climate change causes, of higher prices.
Higher mortgage rates punish a minority of the household sector for an economy wide – households, businesses, government and rest-of-world – reality.
More can be said, e.g., unequal impact on households with mortgages and those without, and the imaginary non-accelerating inflation rate of unemployment (NAIRU) that cannot be measured with any accuracy, and the effective transfer of wealth between sectors.
Don’t households have a moral ownership of their savings?
There is clearly a need to consider price gouging and policy failures as mentioned in this media release:
Also, there is a need for a better understanding of how higher interest rates feed into high prices and a CPI not falling as quick as it otherwise would. RBA decisions can add to inflation.
Analysis of inflation should be isolated to the reasons for real world changes in prices and away from what the RBA believes it knows about consumer, labour and business inflation expectations.
Government could respond to unexpected cost-of-living increases with short-term fiscal support. Have a look at the recent Japanese experience – no major increase in interest rates, targeted fiscal response, falling inflation.
Both Mr Redican and Dr Ellis worked for the RBA and the best they have come up with is ‘adjust your prices by our ideological based 2.5 per cent.’
The RBA should not be trying to influence prices that are not sensitive to the OCR, and should not be basing decisions on beliefs about inflation expectations.
We should be asking better questions for a critical analysis of mainstream economic thinking, hopefully resulting in a better social distribution of societies economic benefits and burdens.
About the author
Robert Bibo BEc GradCertMgt worked at the Australian Bureau of Statistics from 1985 to 2009 in the National Accounts and Labour Force teams.