John Quiggin and the Overton Gradient

(Not to mention Overton’s Elephant and Overton’s Mouse)

With inflation stuck at 4%, what a terrible problem that it will probably take a deliberately engineered recession to get it back into target. If only the optimal rate of inflation were 4%. Oh wait … No-one can be sure what the optimal rate is, but from the flimsy knowledge we have, 4% is a better guess than 2-3%. Yet to even say so is to play the role of the ‘wet’, the soft-headed person who won’t make hard choices. Welcome to Overton’s gradient.

Named after the American free-market policy analyst Joseph Overton, the Overton Window defines what policy options can be seriously considered and what is regarded (without further thought) as beyond the pale. Thus when Cambridge Economics Professor Cecil Pigou suggested confiscating a portion of the wealth of the richest Britons to pay for WWI, the suggestion was not within the Overton Window, not worthy of serious consideration.

The Overton Window is policed by a committee known as the VSOWP — which, as we all learn in Public Policy 101 stands for Very Serious Overton Window People. The VSOWP are convinced for instance that we couldn’t have inheritance taxes in Australia. So no mainstream politician goes so far as to mention them. Why not? Well because, and did I mention that no politician mentions them? Anyway, look over there.

Of course other things being equal the VSOWP are correct. If you just get up in Parliament and say ‘what this place needs is death duties’ you will not be treated as a political mastermind. But the same can be said of raising any tax. But introduced as the least painful of available options next time there’s a crisis and a fiscal crunch — it could easily squeeze its way into the Overton Window. Except that it won’t because … well you have to put your application into the VSOWP.

In any event, I’ve previously expanded the use of the adjective Overton to allow for the Overton Juggernaut — that’s what every Very Serious Person knows, just knows whether it’s right or not. You know, like it certainly wouldn’t be good to change course and move interest rates sharply lower when forecasters are predicting rising unemployment. And this is itself an example of the Overton Gradient. The Overton Gradient tells you, that when you have a choice, there’s a soft option and a hard one. And soft-options are for weakly, ill-formed folk with no moral or even intellectual fibre.

And the nature of the Overton Gradient explains the more specific phenomena of Overton’s Elephant and Overton’s Mouse. The elephant is the fact that 4% is a good guess at the optimal inflation rate. So it looks like the best inflation target. And the mouse is all the other things the Reserve and the other Serious Folks are talking about instead — more productivity, investment, innovation and wellbeing. No problem with any of those, but they should be addressed on their merits. They’re not substitutes for better macro-economic policy.

Over to John Quiggin.

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.

But if the rate of inflation is too low, this policy is limited by the fact that interest rates can’t go ¹ below zero. … If a low inflation target is such a dubious idea, why was it adopted in the first place? The answer, surprisingly enough, comes from New Zealand. The first central bank to adopt an inflation target was the Reserve Bank of New Zealand in 1989. The policy was introduced by the then Reserve Bank governor, Don Brash, later to reinvent himself as a rightwing (and then far-right) politician. Brash was backed by then finance minister, Roger Douglas, whose political career followed a similar trajectory.

A range of 0% to 2% was picked, without any theoretical basis, as the lowest that could plausibly be pursued. As Douglas said later, “I just announced it was gonna be 2%, and it sort of stuck.” While the NZ central bank was the first to adopt a 2% inflation target, others were quick to follow. …

At the time, New Zealand was seen as being a star performer in economic reform, likely to overtake Australia …. In reality, though, New Zealand’s economic performance has been miserable. …

While many explanations have been offered for New Zealand’s relative decline, the simplest is that of repeated failures in macroeconomic management. New Zealand has experienced a string of recessions since the adoption of inflation targeting, mostly reflecting excessively rigid application of tight monetary policy. Contrary to the idea of a recession as a temporary disruption, these recessions (particularly that of the early 1990s and the global financial crisis) seem to have shifted the country onto a permanently lower growth path.

Elsewhere, inflation targeting worked reasonably well until the GFC. But in the long period of depressed activity that followed, central bank interest rates were stuck at or near zero. Despite this failure, central banks retained the power and prestige they had attained in the early days of inflation targeting. Unsurprisingly, they have been highly resistant to any change to inflation targets, even though they have no convincing defence of the status quo. Instead, they rely on the fact that any change would be bad for faith in the central banks.

The recent review of the RBA spells this out. After conceding the strength of arguments for a higher inflation target, the review panel concluded: “Regardless of the merits of higher inflation in general, the Review does not recommend increasing the inflation target during the present period of high inflation. To do so could undermine the credibility of the RBA in responding to future periods of above-target inflation.”Of course, once we have ground our way back down to the target, the idea of raising it will be dismissed; it would be throwing away costly gains. So, if you are struggling with higher interest rates or worried about higher unemployment, remember that this is the price we have to pay to restore the “credibility” of the Reserve Bank.

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