The release of recent data suggesting that inflation appears to be stuck at 4%, above the Reserve Bank of Australia’s target range of 2% to 3%, has raised plenty of concern among economic and political commentators. These commentators might be surprised to learn that many, perhaps most, macroeconomists who have looked at the question have concluded that a 4% inflation rate would be the ideal target, at least providing that wages and other incomes kept pace.
The underlying reasoning is simple. Interest rates are the main tool of monetary policy. In a deep recession such as that following the global financial crisis, or in an emergency such as that created by the Covid-19 pandemic, it is desirable that the interest rate should be well below the rate of inflation. That is, the real interest rate, adjusted for inflation, should be negative.
