2 tanners suggested that the theory looked even more shaky if the banks simply increased profitability by not passing on interest rate cuts (as they appear not to be doing). This then freed them to make higher profits or support riskier speculation (e.g. in houses or stocks), neither of which generate real income.
erratic political environment, leading to insufficient confidence, and then there's overregulation, all of which leads to unwillingness to invest."
kvd: That is a good point. Policy uncertainty looks to be a big factor behind the decline in investment in many high income countries over the last 15 years or so. It looks like we have low investment leading to low growth, increased job insecurity, the rise of xenophobia and hence greater policy instability.
However, I doubt whether we could have no policy change for ten years without a fiscal crisis. If no policy change Involved no increase in government spending in real terms it would actually be a major reform.
In terms of monetary policy, no policy change would involve sticking to the inflation targeting rules we currently have. However, the Reserve bank seems to have a problem in convincing people that it has the means and the determination to meet those targets
Winton and kvd continued in agreement: "kvd, I agree that the idea that any amount of inflation can be optimal seems peculiar. The way I rationalise it is that because of quality change issues, price indexes tend to overstate the rate of inflation. So, our target band might not be too far away from zero inflation. We also need to consider expectations. If people have come to accept 2% p.a. CPI increase is the norm, it will take many years to persuade them that they should expect the rate of CPI increase to be 0% p.a. in future."
The issue about that dreaded policy instability is something we have talked about here a fair bit. It affects macro-economic policy, but it is still more common in other policy areas. It creates confusion. I am reasonably bright and indeed have been a policy adviser on macro-economics, tax, finance and industry policy as well as aspects of social policy, but I get totally lost now. It makes planning difficult and, to the degree that policy success depends upon the expectations, it ensures policy failure.
So we might well be better off freezing policy, accepting imperfections and just getting on with it.
On the question of inflation and inflation targeting and the associated question of what (if anything) to do about deflation is again something that we have talked about. The original idea that a central bank should set an inflation target actually dates back, I think, to the stagflation of the 1970s.
Thinking of Jasper, the Reserve Bank web site describes the Bank's role in these terms.
The Reserve Bank of Australia is Australia's central bank. It conducts monetary policy, works to maintain a strong financial system and issues the nation's currency. As well as being a policy-making body, the Reserve Bank provides selected banking and registry services to a range of Australian government agencies and to a number of overseas central banks and official institutions. It also manages Australia's gold and foreign exchange reserves.
The role and functions of the Reserve Bank are underpinned by various pieces of legislation. The Bank is a statutory authority, established by an Act of Parliament, the Reserve Bank Act 1959, which gives it specific powers and obligations. In terms of the Act, there are two Boards: the Reserve Bank Board and the Payments System Board.
The Reserve Bank Board's obligations with respect to monetary policy are laid out in Sections 10(2) and 11(1) of the Act. Section 10(2) of the Act, which is often referred to as the Bank's ‘charter’, says:
It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank ... are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:
a. the stability of the currency of Australia;
b. the maintenance of full employment in Australia; and
c. the economic prosperity and welfare of the people of Australia.
Section 11(1) of the Act covers the need to consult with Government; "the Reserve Bank Board is to inform the Government, from time to time, of the Bank's monetary and banking policy."
The ‘charter’ of the Payments System Board is defined in section 10B(3) of the Act as follows:
It is the duty of the Payments System Board to ensure, within the limits of its powers, that:
a. the Bank's payments system policy is directed to the greatest advantage of the people of Australia; and
b. the powers of the Bank under the Payment Systems (Regulation) Act 1998 and the Payment Systems and Netting Act 1998 are exercised in a way that, in the Board's opinion, will best contribute to:
(i)controlling risk in the financial system;
(ii) promoting the efficiency of payments system; and
(iii) promoting competition in the market for payment services, consistent with the overall stability of the financial system; and
c. the powers and functions of the Bank under Part 7.3 of the Corporations Act 2001 are exercised in a way that, in the Board's opinion, will best contribute to the overall stability of the financial system.
Winton Bates wrote:" Jim, A good place to start the discussion might be with the article Noric referred to in the discussion on your previous post. I think we are dealing with a secular low investment problem rather than a Keynesian liquidity trap."
This is the article Noric referred to: "We’re in a Low-Growth World. How Did We Get Here?" I think a key point with the liquidity trap as I interpret it is that its an outcome of other things that then has its own effects. One cause is a reduced desire to invest.
On the Reserve Bank, two points flowing from discussion: