The rules on how we conduct monetary policy

Something happened this week that occurs only about once a decade, an event that deserves much of the credit for our avoidance of a severe recession for 25 years and counting.

It was the announcement of a new agreement between the elected government, represented by the Treasurer, Scott Morrison, and the newly appointed governor of the Reserve Bank, Dr Philip Lowe, recorded in a "statement on the conduct of monetary policy".

The statement re-affirmed the government's willingness to allow the Reserve, our central bank, to set "monetary policy" - to manipulate the level of short-term and variable interest rates paid and charged in the economy, so as to influence the strength of demand - without reference to the wishes of the politicians.

The length of the period of continuous growth in the economy is measured from the end of June 1991, the last quarter of contraction during the severe recession of the early 1990s.

It's no coincidence that the era of central bank independence began just a few years later in 1993, first informally under the Keating government and then formally under the Howard government in 1996, at the time of the appointment of Ian Macfarlane as governor.

Handing control of interest rates from the pollies to the econocrats has been a huge success, though it's important to remember that, in the time since then, the economy contracted - got smaller - in the December quarter of 2000 and again in the December quarter of 2008, with unemployment rising significantly on both occasions.

That's why I always say it's been 25 years since our last severe recession. We've had two small recessions since then, though they were too short and shallow for anyone but economists to remember them.

But their very mildness is testimony to the success of the move to central-bank independence. The econocrats move interest rates up or down according to their best judgement on what's needed to keep the demand for goods and services as stable as possible.

The pollies were too inclined to let the approach of the next election influence whether rates should be going up or down.

Of course, another factor has contributed to the vastly improved management of our economy: all the "micro-economic reform" of the 1980s and '90s.

The floating of the dollar, the removal of import protection, the move to enterprise wage bargaining and myriad small acts of deregulation in particular industries have greatly increased the degree of competition within our economy, making it more flexible in its ability to cope with economic shocks and less inflation-prone.

So the managers of the macro economy have found it easier to keep the economy on an even keel, avoiding extremes in inflation or unemployment.

When we joined the rich-world fashion of making central banks independent, we adopted another new idea of making a target for the rate of inflation the main guide for decisions about changing interest rates.

While other countries set hard and fast inflation targets of zero to 2 per cent, we set a target that not only was higher - 2 to 3 per cent - but was also less hard and fast.

We were required to hit our target only "on average, over the cycle". So when you take the average of the inflation rate over a reasonable period, the result always has to be 2-point-something.

We were criticised for our target's fuzziness, but we've since won that argument. The others weren't able to achieve their "hard-edged" targets and had to modify them, whereas we've always achieved ours, even though we've been outside the range for 46 per cent of the time.

This week, in his regular testimony before a parliamentary committee - one of the conditions of accountability and transparency required in return for the Reserve's independence - Lowe argued that the target's flexibility meant there was no need to change it, even though it seems likely the world has entered a period of lower inflation.

This third version of the statement on the conduct of policy contained two minor changes.  "On average, over the cycle" became "on average, over time".

The two words mean much the same thing. How long is "over time"?  As the statement says, it means "the medium term". How long's that? We're not told, but I'd put it somewhere between five and 15 years.

The second change made clearer the link between monetary policy and the stability of the financial system.

In setting interest rates, the Reserve will take account of the need to ensure people can always borrow, lend and make payments, and ensure the failure of a particular financial institution doesn't cause any doubt about the stability of the others.

When the inflation target was first adopted, some people feared it meant the Reserve wouldn't worry about unemployment or growth. More than 20 years later, we know those fears were unwarranted.

The Reserve sees low and stable inflation as a precondition for achieving strong growth in employment and income.

And so it's proved. The Reserve has shown that the best way to keep unemployment low is to keep recessions as shallow and far apart as possible.

The flexibility built into the formulation of the inflation target is designed to keep inflation in perspective, absolving the Reserve of the obligation to crunch the economy whenever inflation pops its head above 3 per cent, or madly rev up the economy whenever inflation drops below 2 per cent.

Monetary policy is the primary "arm of policy" used to achieve "internal balance" - price stability and full employment or, more simply, low inflation and low unemployment.

It does need backup, however, from the other arm, "fiscal policy" - the manipulation of government spending and taxation in the budget - whose primary goal is "fiscal sustainability" - making sure public debt doesn't get too high.

There's much more to the story, but that's enough for now.

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Brave minister wants us to think about road user charges

If you're searching for a politician with courage, smarts and foresight, meet Paul Fletcher, Malcolm Turnbull's Urban Infrastructure Minister. He's so unlike your typical gutless pollie he reminds me of Paul Keating.

Fletcher gave a speech last month in which he raised issues from which most politicians would run a kilometre. He thinks heavy vehicles – trucks weighing more than 4.5 tonnes – should pay road-use charges that more accurately reflect the huge damage they do to our roads. That's brave.

But he thinks ordinary drivers should also be paying a road-user charge. That's not brave, it's outrageous.

Fletcher, however, has his own arguments to persuade us it's really quite sensible.

He says he's worried about how the federal government will be able to maintain its contribution to building and maintaining the nation's roads when the move to more efficient cars causes its revenue from fuel excise to fall away.

He reminds us that, whatever the price of petrol, it's almost 40¢ a litre higher than it needs to be, thanks to the federal government's fuel excise.

This means, of course, that how much tax you pay is partly a function of your vehicle's fuel efficiency. So someone driving a 12-year-old Holden Commodore pays 4.5¢ a kilometre, whereas someone in a six-year-old Renault Megane pays 3.5¢.

But get this: someone with a late-model Toyota Prius hybrid pays just 1.5¢ a kilometre and someone who's paid $125,000 for one of the new all-electric Teslas pays exactly … nothing.

See the problem? As we all do the right thing and move to more environmentally friendly driving, the government's excise revenue will be going down, not up.

Today, electric vehicles make up only about half a per cent of our vehicles, but projections put that up to 30 per cent within 20 years.

Then how will we pay for our roads?

Fletcher's answer is that we need to move to funding them more directly by a user charge – say, one based on the number of kilometres you drive.

He stresses this isn't an argument for motorists to pay more. They already pay a lot more than federal excise to drive their cars, including state rego fees and stamp duty.

Indeed, if you pull together all the taxes and charges we pay that are in any way associated with cars and trucks – including under GST and the fringe benefits tax – you can get to a total of about $30 billion a year, of which fuel excise accounts for only about a third.

This compares with total spending on building, maintaining and operating roads – federal, state and local – of about $25 billion a year.

So Fletcher's idea is to rationalise this mish-mash of taxes and charges and replace them with a road-user charge that would be much more visible.

But this is where he reminds me of Keating, who often used wrong but more appealing arguments to persuade us to accept needed but unpleasant measures.

Fletcher has picked up a long-standing piece of motoring organisation propaganda – that every cent of tax paid by motorists should go back into roads – and given it the status of a self-evident fiscal truth.

The truth is there's never been any link – legal or informal – between the taxes and charges on petrol and cars, and the amount governments spend on roads.

Nor should there be. Governments have to pay for 101 services we demand of them apart from roads. So they have to raise a lot of revenue, which they do by taxing a wide range of activities and things, not just one or two.

What they tax tends to be what we're used to them taxing, since we have such knee-jerk opposition to anything we can condemn as a "new tax".

The feds' spending on roads is equivalent to only about two-thirds of what they raise from fuel excise. So should excise receipts decline in the future, this will be a problem for the whole budget, not for road spending in particular.

Fletcher is right to think that user charges would be an improvement because their greater visibility would encourage us to be more economical in our use of roads.

That's particularly true of heavy vehicles, because it's they that do most of the damage to our roads. We don't want goods being moved interstate by road rather than rail because we're charging semi-trailers and B-doubles only a fraction of the cost of the damage they do.

But if the rest of us had to pay a user charge whose purpose was to cover all the remaining costs of roads and to replace all the other taxes and charges, that might be neater and more visible, but it would be a lost opportunity to help us reduce a different, fast-growing cost for city motorists: congestion.

The cost of congestion is the cost I impose on other motorists by driving my car at the same time they do.

And the way to reduce it – as well as the spending needed for new motorways and even public transport – is to replace some of the tax we pay with a user charge that varies by location, time of day and distance travelled.

As Fletcher says, there's a lot more thinking to be done about how we pay for roads.

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