Question

Over the last 30 years, does the quantity theory explain inflation over the trend in Australia?

Answer 1

Yes..Over the last 30 years, the quantity theory explain inflation over the trend in Australia.Australiaís inflation performance over the past four decades is illustrated in Figure 1. Two measures of
inflation are shown: the Treasury underlying series, which, until recently, was the main measure of
core inflation in Australia, and the Statisticianís new inflation series.5
The shaded band indicates the
current target of 2-3% inflation over the medium term that has been the objective of monetary policy
since 1993. There are several striking features of the graph. When viewed over the longer run,
inflation has been highly variable, so that the 1990s emerge as a period of unusual stability. Also
striking is that since the 1970s, there has been a tendency for each cyclical peak in inflation to be
lower than the one before it. Since the early 1990s, inflation has been maintained at a rate not
witnessed for more than a generation. Furthermore, in the period since the adoption of the inflation
target, it is clear that inflation has been below 2% for longer than above 3%.
Many of these features are not, however, unique to Australia. Comparing inflation performance in
Australia with that in the OECD, it is clear that there is a fair degree of similarity (Figure 2).6
The timing
of most major swings in inflation is roughly coincident, reflecting some commonality of shocks, rough
correlation of business cycles and broad similarities in the stance of monetary policy. A trend reduction
in inflation since the 1970s is common to many countries. So too is the shift to a regime of low, stable
inflation and the tendency for inflation outcomes to be either below target or in the lower part of
tolerance intervals. However, until recently, inflation in Australia tended to be higher, on average, than
in the OECD and subject to greater oscillations.

Inflation in the past decade in most industrialised countries, including those without inflation targets,
has been surprisingly low. At issue is whether this outcome is the product of favourable shocks or a
fundamental change in the inflation process.
We find that some of the determinants of inflation in Australia have undergone unusual or structural
change in recent years, the effects of which have been clearly disinflationary. Consequently, an
unexpectedly benign inflation environment has played an important role in the low inflation outcomes
of the 1990s. We also find tentative evidence that, for some determinants, there has been a change in
their relationship with inflation. These changes are not very statistically significant, and should be
interpreted cautiously. They may, however, be economically significant. Furthermore, they appear to
have been evolving throughout the past decade. This leaves open the possibility that some forces may
be emerging that could help reduce the variability of inflation in response to shocks.
Despite this possibility of change, it cannot be said that the inflation process in Australia has become
permanently more immune to shocks. The future may hold unhelpful influences on inflation.