The RBA and Expectations Management
The RBA’s decision to leave the OCR unchanged at its February Board meeting is the subject of a lengthy discussion by Adrian Rollins in yesterday’s AFR. The discussion centres on whether the surprise decision was a failure by the market to interpret the signals being sent by the RBA, or whether it was a failure on the part of the RBA to appropriately condition market expectations. This is a joint problem, but one made worse because the RBA is not very good at communicating in a consistent, systematic and structured way.
This is an issue that is more serious than just wrong-footing the market over the outcome of a given Board meeting. Expectations for the future real official cash rate are critical to the transmission of monetary policy and are probably more important to the stance of policy than the actual cash rate. Changes in these expectations can even substitute for changes in the actual policy rate. Poor communication can lead to the effective stance of policy being easier or tighter than the Bank intends, requiring a more activist approach to changes in the OCR than would otherwise be necessary.
For example, it was not unusual for the market to periodically price in a new easing cycle during the 2002-2008 tightening episode. This de facto easing in policy contributed to inflation getting out of control and increased the amount of tightening ultimately required. It is thus very much in the RBA’s interests to ensure that market expectations align with its views.
posted on 05 February 2010 by skirchner
in Economics, Financial Markets, Monetary Policy
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“The discussion centres on whether the surprise decision was a failure by the market to interpret the signals being sent by the RBA, or whether it was a failure on the part of the RBA to appropriately condition market expectations.”
Or maybe its just sour grapes on the part of economic commentators who were made to look silly.
Posted by .(JavaScript must be enabled to view this email address) on 02/05 at 01:57 PM
On a slightly related note, as Bassanese picks up in the AFR today, have you had a look at the various measures they now use for underlying inflation. Nice of them to tell us that underlyling inflation is now more than trimmed mean, weighted median and even CPI ex vols and deposits and loans. It is a bit of work trying to replicate the city-based weighted median and annual distribution trimmed mean. I’m not even sure you can as they may seasonally adjust the individual components (like the original TM and WM series).
So they are targeting an inflation rate that is ill defined and not available to the public.
Fantastic.
Posted by .(JavaScript must be enabled to view this email address) on 02/08 at 10:48 AM
Harry, I have made similar criticisms of the lack of definition around the inflation target:
http://www.cis.org.au/policy/autumn_08/Links/kirchner_autumn08.pdf
The TM and WM series are not well presented at the moment, which makes modelling difficult. It is an issue I plan taking up in an op-ed in the near future.
Posted by skirchner on 02/09 at 05:32 PM
Some good criticisms in that piece thanks.
You make the point about Warburton implying vested interests within the Board members - made me think of the recent interview Kraehe had with Dow Jones.
He was all about skills shortages, unemployment having peaked, risks sweked to cost pressures and inflation rather than to the demand side.
As I thought it would have been manufacturers lamenting recent OCR rises and AUD strength, I presumed he would have been one of the ones previously arguing for a pause.
I (and a few others) in the dearth of communication from the RBA over the Christams break took this as being very hawkish and if not premeditated then at least a signal.
Weren’t we wrong… Of course if we had a voting record from last week’s meeting we would actually know if Kraehe is something of an inflation hawk and could thus interpret his comments accordingly.
Sour grapes yes, but I don’t think monetary policy is supposed to be as exciting as this.
Posted by .(JavaScript must be enabled to view this email address) on 02/10 at 10:10 AM