The RBA is failing on the most basic measures and it’s time it was held to account

Fri, 19 Oct 2018  |  

This article first appeared on the Business Insider website at this link: https://www.businessinsider.com.au/rba-policy-failure-stephen-koukoulas-2018-10 

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The RBA is failing on the most basic measures and it’s time it was held to account

How’s this for an economic plan?

The RBA cuts the official cash rate to 0.5 per cent and on the back of that, the unemployment rate drops to 4.75 per cent on a sustained basis, underlying inflation hits the mid-point of the 2 to 3 per cent target range and annual wages growth lifts to 3.25 per cent.

This is what a range of credible economic models suggest would happen with such a simple and transparent monetary policy move from the RBA. And what’s more, it is free to implement!It would be, on all measures, a good economic outcome.

So why is the RBA not going to do it?

What kind of monetarist poltergeist has possessed them it is now a bad idea to try and hit their inflation target, put tens of thousands more Australians into work, and stoke a much-needed rise in wages growth? 

Why is the RBA the only central bank on the world seemingly obsessed with peripheral issues when the inflation target has been missed so comprehensively for so long?


Perhaps we can turn this monetary policy issue on its head for a moment.

The same economic models that produce those better economic outcomes with a 0.5 per cent cash rate show that if the cash rate stays at 1.5 per cent, the unemployment rate will not fall below the 5 per cent level recorded today at any stage through to 2022, underlying inflation will likely remain below the target range for a couple more years and wages growth will be condemned to stay well under 3 per cent, quite possibly near 2.5 per cent.

This is the choice the RBA is making by keeping interest rates too high.  

Recall that each 0.25 percentage point on the unemployment rate is equivalent to around 20,000 to 25,000 people. That’s a lot of people the RBA is choosing to keep on the dole queues.

For what?

Policy certainty? Financial stability?

Since the end of 2015, underlying inflation has averaged just 1.75 per cent, a substantial 0.75 percentage points from the middle of the target.

Not since 2014 has underlying inflation hit even the middle of the target.

And based on what we know about the economy, it seems likely that the next two years and more will see this policy failure continue. The costs are huge. Tens of thousands of extra people unemployed. Millions of people with substandard wages increases. All because monetary policy remains too tight.

It could also explain why the path to budget surplus has been slow and very rocky – the RBA has deliberately aimed to see a weaker economy which has curtailed the improvement in the automatic stabilisers in the budget.

Protests about ”house prices” and “household debt” cloud the debate.

But these refrains highlight the other critical error of the RBA – its reluctance to embrace macroprudential policies to address these specific issues when they were needed several years ago.

Those problems, to the extent house prices and household debt are problems, could be easily addressed with policies other than interest rates.

As we are seeing all too clearly now, macroprudential policy tightening has seen credit growth slow, household debt stabilise and house prices fall. Overwhelmingly, at least in recent times, this has been the result of tighter credit policies.

A cut to 0.5 per cent for the cash rate could easily be accompanied by the maintenance of further tightening of those rules if house prices and household debt remain a concern.

The Treasurer and others need to call the RBA to account.

The RBA’s independence is important but it should be called out when the policy settings are holding back opportunities and living standards. Even when the RBA is doing things right it remains answerable to the government — something central bank purists often overlook. Unfortunately for a few tens of thousands people unnecessarily unemployed, the RBA shows no sign of changing its tune.

Like the busker outside Wynyard station tapping on a plastic bucket — tap, tap, tap — the RBA monotonously insists the next move in interest rates is likely to be up, not down, even though its own forecasts show zero upside momentum in inflation from the current inappropriate levels.

The RBA is failing, and its own forecasts show an ongoing failure for the next two years.

Which other body could ever get away with that?

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