After a wild ride during the 1980s, the Australian economy crashed in 1990. On most measures, the subsequent recession was the worst since the 1930s. It proved a defining moment for the Reserve Bank, which finally attacked inflation head on. The Bank emerged from the recession having seemingly conquered inflation, and with new power, focus and resolve. The Australian Financial Review eventually concluded that ‘The Reserve Bank is now a more powerful force for low inflation than at any time in its history.’ This chapter explains how and why the Bank (and Keating) broke the stick of inflation.

CREDIBILITY CRISIS AND RECESSION

Two major factors prompted the Reserve Bank's new resolve about inflation. First, the Bank's uncertain performance in the 1980s, its difficulties in articulating a clear policy framework, and allegations surrounding its relationship with the government, plunged the Bank into a credibility crisis in the late 1980s. For a central bank, lack of credibility is an institutional disaster. A credible central bank has a firm policy stance, an undoubted commitment to low inflation and a track record in dealing with inflation. Financial markets, central bankers and governments all take credibility seriously.