RBA Flags Major Change In Monetary Policy

By Glenn Dyer | More Articles by Glenn Dyer

Another major change in monetary policy from the Reserve Bank yesterday which will change the timing of interest rate movements in years to come as the bank turns its back on old, established ways of reacting to events in the economy that are perceived to be inflationary, such as a big wage rise or a surge in oil prices.

The change will force investors to reconsider the way they regard inflation and protecting themselves at a time when there is every likelihood that cost pressures will not be a serious problem for years to come, thanks to COVID and the changes it is wreaking on the economy, investments and consumer behaviour.

For example if inflation is not going to be a concern, remaining under 2% and even lower, does gold make sense as a hedge, or will it be seen as a way of getting trading profits because the cost (interest) of speculating in it, silver and other products, will remain at record lows?

The RBA now wants to see the ‘whites’ of inflation’s eyes’ (to corrupt an old cliche) before starting to think about moving interest rates.

That will see a lot of economists, especially those high profile ones in the markets, without very much to do. If you can’t take a punt on a rate move and try and second guess the RBA, what can you do?

It will be a case of actual rather than prospective is the order of the way so far as interest rates and employment will be looked at from now on.

The old monetarist approach to monetary policy of cranking down on inflationary pressures by interest rate rises has been swept aside in Australia. Expectations have been replaced by actual, sustained figures – months of rising prices and months of falling unemployment.

For years now central banks have tried to change monetary policy – raising or cutting interest rates on the basis of what the data suggest might happen a little down the track.

The banks and many economists have come to rely on inflationary expectations – as in surveys of consumer sentiment (where questions about likely future price movements are asked), pricing through inflation-linked bonds, and anecdotal reports from businesses in regular surveys.

That has changed, at least for Australia (and probably in the US if the newish monetary policy stance on inflation and unemployment is any guide). According to Reserve Bank Governor Philip Lowe, prospective is out so far as inflation and unemployment/employment are concerned, actual is in.

In a virtual speech on Thursday, (https://www.rba.gov.au/speeches/2020/sp-gov-2020-10-15.html) Dr. Lowe revealed the new ‘actual’ approach;

“In terms of inflation, our forward guidance has been forward-looking – we have focused on the outlook for inflation, not just current inflation. This was a sensible approach when the inflation dynamics were relatively stable and well understood. In today’s world, things are much less certain. So we will now be putting a greater weight on actual, not forecast, inflation in our decision-making.

“In terms of unemployment, we want to see more than just ‘progress towards full employment’. The Board views addressing the high rate of unemployment as an important national priority. Consistent with our mandate, we want to do what we can do, with the tools we have, to ensure that people have jobs. We want to see a return to labour market conditions that are consistent with inflation being sustainably within the 2 to 3 per cent target range.”

This means, as Dr Lowe said on Thursday the RBA will not move rates until inflation is within the target range and for some time. Likewise the fall in unemployment will have to have happened and be sustained.

“The Board will not be increasing the cash rate until actual inflation is sustainably within the target range. It is not enough for inflation to be forecast to be in the target range. While inflation can move up and down for a range of temporary reasons, achieving inflation consistent with the target is likely to require a return to a tight labour market.

“On our current outlook for the economy – which we will update in early November – this is still some years away. So we do not expect to be increasing the cash rate for at least three years.”

And why the change? The RBA is clearly frightened that if it continues to use inflationary expectations as a basis for changes in monetary policy (tightening especially), it could choke off a tentative recovery and gathering fall in jobless numbers just as those gains are making headway. The US Federal Reserve tightened in 1937 which plunged the US economy back into a second depression.

That rate rise was based on misplaced fears about the pace of recovery from the Great Depression earlier in the decade. That example has remained with central bankers for generations.

In Australia there were a series of rate rises in 1994 from the RBA that choked the slow recovery from the recession of the early 1990’s. Those increases totalled a large 2.75% and put a throttle on the recovery going into the 1996 election which the ALP lost.

And by the way, the RBA will cut rates again. Dr Lowe said in his speech the RBA remained open to further monetary easing.

“When the pandemic was at its worst and there were severe restrictions on activity we judged that there was little to be gained from further monetary easing,” he said.

“As the economy opens up, though, it is reasonable to expect that further monetary easing would get more traction than was the case earlier.”

Glenn Dyer

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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