Andrew Hauser explains why the RBA acted ‘proactively’ on inflation
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The news: Research undertaken by the RBA has strengthened the case for its recent proactive action against inflation, supporting the decision to lift rates on three consecutive occasions earlier this year, according to RBA deputy governor Andrew Hauser.
The context: The speech delivered on Wednesday was titled “The Straight Line Belongs to Man, The Curved Line Belongs to God” for the Sir Douglas Copland Lecture at the Economic Society of Australia (Victoria).
Hauser said that recent RBA research has confirmed the non-linear relationship between inflation and unemployment, an insight that follows from economist Bill Phillips.
The Phillips curve details the nonlinear inverse relationship between inflation and unemployment and is a key framework used by the RBA when making monetary policy decisions.
Hauser later noted that in general “nonlinearities in the Phillips curve suggest that policy should respond proactively to an inflationary shock when we are already on the steep part of the curve — and that is what the Monetary Policy Board has done in recent months”.
This is because when the economy sits at the steeper end of the curve during a period of high inflation, the nonlinear relationship means “credible disinflation in such circumstances” incurs less of a cost to economic activity “than at the flatter part of the curve”.
However, he also stressed that it is also important for central banks to remain aware of the factors that affect nonlinear economic relationships, not just the fact that it is nonlinear. This is key to central banks determining “the curve’s position, shape and response to shocks” and whether it is appropriate to act proactively against inflation shocks.
He noted, for example, that “the same labour market frictions that lead to Phillips curve nonlinearities can also make it harder to bring unemployment down quickly, once it rises, without a sharp rise in inflation”.
The RBA has also integrated three non-linear labour market drivers of inflation into an Australian model to help inform monetary policy.
This includes the observation that wages rarely fall in nominal terms, measure of labour market tightness and nonlinear hiring costs.
Hauser also announced the release of notes authored by RBA staff in a new “insights” series that details the research that informed his speech.
The source: RBA speech
