Effective Implementation Of Inflation Targeting Policy: A Comparative Analysis Of Australia And Canada

Inflation Targeting Policy in Australia

The attempt to adapt an inflation targeting policy in Australia began since 1993.  Governor Fraser took the initiative to set the targeted inflation within 2 to 3 percent. Unlike Canada an =d New Zealand, there was no sudden shift in policy regime in Australia. There was neither any formal agreement between central banks and government during this time. Instead, RBA took a medium term strategy along of inflation targeting in relation to existing institutional set.

Economic outcome of inflation targeting policy in Australia 

Inflation

During 1970s and 1980s, Australia accounted a poor record for balancing inflation. Inflation rose to a relatively high level following oil price shocks and a large upward shift in wags during 1970s. The inflation rate in Australia was relatively high than other OECD nations for the entire period of 1980s with average inflation being 8.5 percent (Melino, 2012).

Several monetary policy tools were used during this time to stabilize the economy. Until 1980s, government maintained fixed or adjusted pegged exchange rate regime. After the regime of floating exchange rate in 1983, attempt was taken to achieve monetary targeting through checklist approach. The inflation though had declined after 1990/91, there remained a risk of rising inflation following further recessionary hit. Since the undertaking of the policy of inflation targeting, inflation rate in Australia averaged to 2.6 percent. The inflation outcome in Australia was consistent with the targeted inflation (Debelle, 2018). After the introduction of inflation targeting, fluctuation in the interest rate decline significantly with inflation varying around 2.5 percent.

Output

The economic growth rate in Australia averaged around 3.7 percent since the inflation targeting policy. The average growth rate was higher than that during 1970s and 1980s with growth rate being 3.25 then. The economy of Australia not only gained in terms of higher average growth but also in terms of a lower volatility in output (Bernanke et al. 2018). The standard deviation of year ended GDP growth was 1.1 percent in 1990s as compared to a standard deviation of 2.5 during 1980s and 1970s.

Table 1: Macroeconomic performance before and after inflation targeting

	Real GDP Growth	Unemployment Rate	Headline CPI Inflation	Underlying Inflation
Annual Average	Standard Deviation	Annual Average	Standard Deviation	Annual Average	Standard Deviation	Annual Average	Standard Deviation
1973-1993	2.8	1.2	6.9	2.2	8.8	1.2	8.4	1.1
1993-2017	3.21	0.6	6.3	1.6	2.5	0.4	2.6	0.2
2007-2017	2.5	0.4	5.4	0.6	2.3	0.4	2.5	0.2

In Canada, the inflation targeting policy was introduced in February 1991. Finance minister announced the policy in a budget speech. It was then simultaneously confirmed by a press release of bank of Canada. In this policy, the government of Canada expressed its target to lower the inflation rate from current level of 5-6 percent to 2 percent within 1995 (Berument & Froyen, 2015). The success of the inflation targeting policy can be evaluated in terms of performance of the economy after the IT policy.

Economic Outcome of Inflation Targeting Policy in Australia

Level and stability of price level

The above figure showed the annual inflation rate of Canada from 1975 to 2004. From the figure, it is clear that average inflation rate was much lower in the period after 1991 when the inflation targeting policy was taken as compared to the level of inflation in previous 15 years. The level of inflation also seemed to be less volatile following adaption of inflation targeting policy.

In Canada, the decline in inflation rate and relative stability was not the sole result of inflation targeting policy (Beaudry & Ruge?Murcia, 2017). The spread of globalization and increased economic integration was partly responsible for stability in the price level.

Volatility in output growth

A more general view regarding the operation of inflation targeting policy is that maintain a low and stable inflation might come at the expense of high volatility in the output growth. Figure 2 presents the trend in real GDP growth of Canada for a period ranging between 1975 and 2004. The figure also shows the output gap for the same period. From the figure, it is seen that Canada gained a greater stability in terms of both output growth and output gap.

Canada was one of the some countries that had experienced an improvement in economic policy and economic performance despite volatility in the economic environment (Chen et al. 2018). There was a lot of improvement in monetary policy of Australia such that it was sufficient to offset volatility in the economic environment.

Table 2: Macroeconomic performance before and after inflation targeting

Table 2: Summary statistics in the pre inflation period and the post inflation period.
Year	1962-1990	1990-2011	1995-2011
Annual Real GDP Growth	4.02	2.42	2.63
Inflation Rate	5.75	2.05	2.00
Annual Labor a productivity Growth	1.93	1.23	1.18
Real Wage Growth	2.09	1.02	1.20

Table 3: Comparative analysis of the effect of inflation targeting between Australia and Canada

Macroeconomic Summary Indicators
	Annual CPI Inflation (Average, percentage points)
1985-89	1990-94	1995-99	2000-04
Canada	4.4	2.5	1.7	2.4
Australia	7.7	3.3	2.2	2.7
	Year-ended CPI inflation (standard deviation, percentage points)
1985-89	1990-94	1995-99	2000-04
Canada	0.4	2.1	0.6	0.9
Australia	1.3	1.7	0.9	0.3
	Year-ended GDP growth (standard deviation, percentage points)
1985-89	1990-94	1995-99	2000-04
Canada	1.5	2.4	1.6	1.5
Australia	1.6	2.1	0.8	1

Impediment to inflation targeting policy in Canada 

Despite the fact that both Australia and Canada gained from the settlement of inflation targeting policy, Australia is marginally in a better position compared to Canada. The impediment to the existing inflation targeting policy is the concern related to financial stability of the country. Attaining financial stability was long since the target of Bank of Canada. This concern in recent years led to several new initiatives.  The crisis of 2008 attracted much attention to the policy goals of financial stability. The inflation targeting policy of Canada was not sufficient to maximize the social welfare in the nation.

The financial crisis experience of Canada raised the concern that Canada need to focus on achieving the target of financial stability. Two critical issues relating to inflation targeting policy in Canada include price level versus inflation targets and determining the suitable inflation rate in Canada (Chaban & Voss, 2016). These issues are important for two reasons: Improvement in Canadian economy and changes in structure of the economy. The advancement in economic structure posed challenge to dynamics of inflation targeting (bankofcanada.ca, 2018). The economy undergone severe changes since the design of inflation targeting policy. The inflation persistence has declined substantially and the forecasting ability of the set policy thus have deteriorated.

Inflation

The increased volatility in US – Canada exchange rate and increase in prices of some of Canadian assets raised question for the role of monetary policy under the circumstance of recession. The additional challenge had posed by the decline in Canadian interest rate to the lowest level. Another culprit of inflation targeting is the demographic features of the nation. In a society with aged people, they have a general tendency to shift away from spending and increase their saving. This causes a decline in demand for goods and services lowering the price. It also reduces the long-term inflation rate consistent with potential output. Once there is a fall in neutral interest rate, the bank has been left with little room to adjust the overnight rate.

Fiscal policy in Australia and Canada during global financial crisis

GFC and Australia fiscal policy 

Australia took the combination of fiscal and monetary policy to protect the economy from hit of the crisis. The policy initiatives though started with a cut in interest rate by nearly 100 basis points the second major policy response was in form of fiscal stimulus. After the announcement of financial stability measures to rescue the economy from the global financial crisis, government announced a fiscal stimulus package of $10.4 billion to support economy expansion (Obstfeld et al., 2016). The first stimulatory package constitutes 1 percent of Gross Domestic Product.

The fiscal stimulus consists of expenditure in several aspects (rba.gov.au, 2018). In the first package, $8.7 billion was supposed to flow to low income families and pensioners in terms of cash bonus. $.5 billion was assigned to support investment in housing construction ad $187 was given for investment in new training places. Before conducting the fiscal policy, the responsible government authorities carefully analyzed the possible impact of the fiscal policy and designed the fiscal structure that best suited the economy.

Government provided the fiscal packages to the relatively weak sectors of the economy. The weak sectors in time of financial crisis include consumption and investment. Consumption and housing then represented 60 percent of Australian economy. Therefore, government considered these two sectors need maximum support during crisis (Combes et al. 2018). The fiscal stimulus in Australia was followed by a well-designed discretionary policy that was timely, temporary and targeted. The fiscal stimulus given to housing sector was immediately effective in the form of a time-constrained grant to the first homebuyers. The aspect of consumption in the stimulatory package was also designed in such a manner that was quickly effective in terms of quick cash bonuses to cares, pensioners, low income household and senior within a few weeks of the policy announcement.

Output

GFC and Canada fiscal policy 

Like Australia, Canada also took considerable fiscal measure in response to global financial crisis. The government of Canada took expansionary fiscal policy during this time. Government announced its economic action plan in January 2009.  The budget though contained a commitment towards fiscal management; it clearly reflected a shift to fiscal expansion (Aquanno & Brennan, 2016). Government conducted stimulatory spending in order to stabilize the economy in the short run. Central to the budget was introduction of a robust stimulatory package that involved a combination of different expansionary policy measures.

The policy measures include reduction in the rate of income tax, tax credit to the targeted groups and spending initiatives to boost domestic demand of the economy. In the package, $8.3 billion was spent on the strategy of Canadian skills and transition. The policy aims to support people in the economy who lost their jobs and searched training and skill development. In order to stimulate housing construction government provided a tax credit of $7.8 billion. The government spent $12 billion to fund infrastructural investment. In addition, $7.5 billion support to provide special support to crisis attacked sectors (Makin & Pearce, 2016). These sectors include forestry, auto and manufacturing sector.

Canadian government spent every dollar in such a manner that it provided maximum support to the economy. Because of stimulatory packages given to crisis-ridden sector and reduction in different tax, rates increased the size of fiscal deficit. Government of Canada actually took temporary and extraordinary measure to provide stability to the Canadian economy in the phase of global recession.

Minimizing the impact of global financial crisis: Canada and Australia 

With the global financial crisis in 2008 originated in United State, the economy of Canada entered a recession. The breakdown of financial market of United States affected Canada and several other nations worldwide. In response to crisis, business investment and consumption spending declined sharply in Canada (Li & Spencer, 2016). Following a sharp decline in export by 16 percent, GDP of Canada declined by 3.3 percent over the three quarters. There was a steep fall in business investment in the new buildings and machinery with investment declined by 22 percent.

Australia on the other hand did not experience much downturn in time of GFC. Australia however had not completely escape from the crisis. Economic growth slowed down along with a sharp rise in unemployment and increased uncertainty.  

Inflation Targeting Policy in Canada

Though Australia and Canada both were remained relatively less affected due to crisis, Australia was somewhat ahead to Canada in terms of mitigating the impact of crisis. The primary reason behind strong recovery of Australian economy was the relatively less exposure of Australian banks to financial sector of United State (Kinda, 2015). Some Canadian Banks had major subsidiaries in United State and had a direct and indirect links to financial system of United State. The credit crisis of United State thus had a severe effect on credit market in Canada. In contrast Australian banks were more strongly linked to Asia especially Japan, China, Korea and South East Asian nation. The monetary and fiscal expansion taken to combat crisis thus were made faster recovery for Australian economy.

As evident from the trend in per capita real GDP, though both Australia and Canada recorded a decline but Australia returned to its previous growth path earlier compared to Canada. In terms of other economic indicators, also performance of Australia was far better compared to Canada and other nations (Wanna, Lindquist & De Vries, 2015).

References 

Aquanno, S., & Brennan, J. (2016). The Politics of Canadian Monetary Policy: Reassessing Canadian Inflation, Part II. Journal of Economic Issues, 50(3), 814-833.

bankofcanada.ca. (2018). Issues in Inflation Targeting: Summary. Retrieved from https://www.bankofcanada.ca/research/conferences-workshops/issues-in-inflation-targeting-summary/

Beaudry, P., & Ruge?Murcia, F. (2017). Canadian inflation targeting. Canadian Journal of Economics/Revue canadienne d’économique, 50(5), 1556-1572.

Bernanke, B. S., Laubach, T., Mishkin, F. S., & Posen, A. S. (2018). Inflation targeting: lessons from the international experience. Princeton University Press.

Berument, H., & Froyen, R. T. (2015). Monetary policy and interest rates under inflation targeting in Australia and New Zealand. New Zealand Economic Papers, 49(2), 171-188.

Chaban, M., & Voss, G. M. (2016). Is Canada an optimal currency area? An inflation targeting perspective. Canadian Journal of Economics/Revue canadienne d’économique, 49(2), 738-771.

Chen, Y., Zhang, H., Tam, K. L., & Wu, M. (2018). The Making of Contemporary Australian Monetary Policy-Backward-or Forward-Looking?. International Journal of Economics and Finance, 10(6), 127.

Combes, J.L., Debrun, X., Minea, A. and Tapsoba, R., 2018. Inflation Targeting, Fiscal Rules and the Policy Mix: Cross?effects and Interactions. The Economic Journal, 128(615), pp.2755-2784.

Debelle, G. (2018). Twenty-five Years of Inflation Targeting in Australia | Speeches | RBA. Retrieved from https://www.rba.gov.au/speeches/2018/sp-dg-2018-04-12.html

Kinda, T. (2015). Anchoring Sustainable Fiscal Policy: A New Fiscal Rule in Canada. Selected Issues Paper, IMF Country Report, 15, 23.

Li, S. M., & Spencer, A. H. (2016). Effectiveness of the Australian Fiscal Stimulus Package: A DSGE Analysis. Economic Record, 92(296), 94-120.

Makin, A. J., & Pearce, J. (2016). Fiscal Consolidation and Australia’s Public Debt. Australian Journal of Public Administration, 75(4), 424-440.

Melino, A. (2012). Inflation targeting: A Canadian perspective. International Journal of Central Banking, 8(S1), 105-131.

Obstfeld, M. M., Clinton, K., Kamenik, M. O., Laxton, M. D., Ustyugova, M. Y., & Wang, H. (2016). How to Improve Inflation Targeting in Canada. International Monetary Fund.

rba.gov.au. (2018). The Global Financial Crisis | Explainer | Education. Retrieved from https://www.rba.gov.au/education/resources/explainers/the-global-financial-crisis.html

Wanna, J., Lindquist, E. A., & De Vries, J. (Eds.). (2015). The Global Financial Crisis and Its Budget Impacts in OECD Nations: Fiscal Responses and Future Challenges. Edward Elgar Publishing.