RDP 2001-02: Changes in the Determinants of Inflation in Australia 5. Conclusion

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 have been changes in their relationship with inflation. Unfortunately, these changes are sufficiently subtle and the noise in the data is sufficiently pronounced that, from a purely statistical perspective, it is difficult to be sure that the changes have actually occurred. Despite this, however, if our estimates of the magnitude of these changes are right, they are big enough to be economically important. 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. If these influences are large or persistent inflation may not turn out to be as well behaved as it was in the 1990s. There remains an important role for monetary policy to anchor price expectations and convince the community that, while some variation in inflation is inevitable in the face of shocks, price stability will be quickly restored.