Description of Graphs for Speech by Glenn Stevens, Deputy Governor
‘Inflation Targeting: A Decade of Australian Experience’
10 April 2003
Graph 1: Inflation
The graph shows the year-ended percentage change in the Consumer Price Index (CPI) between 1955 and 2002, excluding interest charges, tax changes associated with the new tax system, and effects of major health policy changes (such as the introduction of Medicare and the 30 per cent private heath insurance rebate).
The graph shows that in the latter half of the 1950s and the early 1960s Australia recorded positive inflation, but that it was quite low on average, although rather variable. From the late 1960s to the mid 1970s inflation was positive and rising, reaching a maximum of 17.6 per cent per annum in March 1975. This was followed by a period of gradual decline, but by the end of the 1980s, inflation was still around 7 per cent. Since mid 1993, coinciding with the Bank's adoption of an inflation target, inflation has been low on average and comparatively stable.
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Graph 2: Inflation and Cash Rate
The graph displays: (i), the target inflation variable, that is, the year-ended ‘Treasury underlying’ inflation rate until the June quarter 1998 and year-ended inflation in the CPI adjusted for tax changes associated with the new tax system and the 30 per cent private health insurance rebate, thereafter; and (ii), the monthly cash rate as recorded on the last business day of each month. The graph shows data for the period between 1990 and early 2003.
The graph highlights the fact that the target variable has on average remained within the 2–3 per cent target band since its adoption in mid 1993, with an average of 2.4 per cent, and a range of 1.4 per cent to 3.3 per cent. The graph also shows how policy has varied to keep inflation within the target band.
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Graph 3: Inflation Expectations
The graph shows: (i), the median expectation of inflation four-quarters ahead, taken from the Melbourne Institute Survey of Consumer Inflationary Expectations, between 1976 and early 2003; and (ii), the bond market expectation of average annual inflation (based on the difference between nominal and indexed bond yields), between 1985 and early 2003.
The graph indicates that both measures of inflation expectations fell sharply around 1990 when actual inflation came down. It also shows that the Melbourne Institute measure has shown a persistent upward bias over the past decade, whereas the bond market expectation has been closely matched with the 2–3 per cent target since the mid 1990s.
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Graph 4: Inflation: Two Possible Scenarios
The graph shows two hypothetical scenarios for inflation, compared with an inflation target of 2.5 per cent. In scenario 1, policy interest rates are set to be consistent with inflation meeting the target in two years' time, but they also prove to be consistent with an asset price boom and increasing leverage. In year 4, there is a crash that affects the financial system, resulting in a recession that reduces inflation well below the target. In scenario 2, policy interest rates are set higher, such that inflation falls below the target and growth is lower over the same two-year horizon. This reduces the risk of a big fall in inflation and growth in year 4. These alternative scenarios highlight the potential trade-off between responding to concerns about rising asset prices several years in advance, and setting policy to keep inflation on target in the near to medium term.
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