Can Unemployment Be Reduced without Violating the Inflation - Should inflation be the sole target

Can Unemployment Be Reduced without Violating the Inflation - Should inflation be the sole target

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The Australian Economic Review, vol. 32, no. 1, pp. 89–95 The University of Melbourne, Melbourne Institute of Applied Economic and Social Research 1999 Published by Blackwell Publishers Ltd, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B B -2 0 2 4 6 8 10 12 02468 1 0 1 2 1 4 M’86 J’87 M’89 M’90 D’90 J’91 D’92 S’93 D’94 D’95 J’96 M’97 M’98 * I thank John Freebairn, Ross Guest, Daina McDonald, Don Harding and Adrian Pagan for helpful comments on previous drafts. However, they should not be ascribed responsibility for the views expressed in this paper. 1. Introduction The setting of monetary policy in Australia is guided by the inflation target—which is to keep the rate of inflation in the range of 2 to 3 per cent in the medium term. 1 This paper considers whether monetary policy can in- duce a permanent decrease in the rate of un- employment without violating the inflation target. The recent history of Australia supports the view that monetary policy can indeed achieve a permanent reduction in the rate of unemploy- ment with no permanent increase in inflation. Consider the period from late 1992 to the mid- dle of 1995. As Figure 1 shows, in this period Policy Forum: Should Inflation Be the Sole Target of Reserve Bank Monetary Policy? Can Unemployment Be Reduced without Violating the Inflation Target? Ian M. McDonald* Department of Economics The University of Melbourne Figure 1 Unemployment and Inflation, Australia, March 1986 to September 1998 Notes : The circles show periods when inflation was roughly constant. If the underlying rate of inflation is used instead of the CPI a similar pattern emerges but with a smaller increase and decrease during the expansion from late 1992 to the middle of 1997. Sources : Inflation: 12-month change in the CPI from Australian Bureau of Statistics, Consumer Price Index , Cat. no. 6401.0. Unemployment: seasonally adjusted rate for persons from Australian Bureau of Statistics, The Labour Force, Aus- tralia, Preliminary , Cat. no. 6202.0. Rate of inflation (per cent change in CPI) Rate of unemployment
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90 The Australian Economic Review March 1999 The University of Melbourne, Melbourne Institute of Applied Economic and Social Research the rate of unemployment fell, from around 11 per cent to just under 9 per cent. The rate of in- flation following this decline in the rate of un- employment was no higher than at the outset. Furthermore monetary policy played a role in both assisting the decline and bringing it to an end. An expansionary monetary stance had preceded the decline and a move to contraction preceded the end of the decline. 2 The pattern of inflation and unemployment observed for the 1992 to 1995 period is consis- tent with the idea that there is a range of equi- librium rates of unemployment. This range pattern is not confined to the post-1993 epi- sode. As can be seen from Figure 1, there is an- other episode, from 1986 to 1989, when unemployment fell with no permanent increase in the rate of inflation. In that episode unem-
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Can Unemployment Be Reduced without Violating the Inflation - Should inflation be the sole target

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