Read about it in my Property Observer column on the RBA today...
I think one under-appreciated problem for the RBA is that it is discovering just how hard it is to raise rates beyond their neutral level following the regime-change in the economy’s interest rate elasticity during the 1990s and 2000s. After more than 20 years of relatively low inflation (care of China flooding global product markets with cheap goods), there are entire generations of Australians who cannot remember what it was like to have high inflation and double digit rates. And these people vote. In 2011 the RBA executive learnt that it no longer controlled its own board, as Ian MacFarlane had done during his easier and more stable reign. Following the governance revolution implemented by a much more open-minded Glenn Stevens, the RBA has unwittingly empowered the vested interests that dominate its board.
With six private sector representatives and a politically-appointed treasury secretary, the RBA has arguably the most inflation-friendly monetary policy committee of any central bank in the developed world. It also just happens to have one of the highest inflation targets in the world, and, just coincidentally, has failed to meet this target during Glenn Stevens’ term (core inflation has average 3.2% per annum since the December quarter of 2006).
Given the decision-making constraints the RBA faces, and the fact that it believes it has one main policy goal (price stability), which is spun into a “dual mandate” in the long-run (by arguing that if it keeps inflation low it will help maximize employment growth), logic would suggest that it should cautiously, and only when persuaded with reliable empirical evidence, lower the price of money to stimulatory levels. To be clear, this is because normalising it again, and pushing rates into restrictive territory, is a vastly more difficult undertaking.
Years ago I argued that given the RBA’s questionable inflation-fighting track-record since Stevens’ term began, and the abovementioned limitations, it should potentially have an asymmetric response function: all things being equal, the RBA should prefer to slightly undershoot rather than slightly overshoot its inflation target. In practice, the opposite has proven to be the case.
The rest is here.
