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31 March 2014

Monetary policy stuff-ups

Monetary policy should be conducted with clear focus and without surprises that confuse people in the financial system or more generally.

Consider the current RBA's recent three-stage approach to currency management.

1. When the currency was initially well above parity with the US dollar, senior RBA staff delivered the unreasonably brutal message - 'What doesn't kill you makes you stronger'.

Perfectly reasonable, you may think. However, for businesses that were unable to become stronger, liquidation or substantial downsizing was the outcome. Manufacturing, inward tourism, exports of educational services all suffered significent overall shrinkage, while most survivers were weaker, not stronger.

2. Then there was a phase in which domestic interest rates were cut, arguably lower than was ideal, combined with gubernatorial exhortation, so-called 'open mouth' policy. This phase of policy had some success and for a while the currency seemed headed to 85 cents, a level 'mentioned' as better than levels in excess of parity. This phase of policy reminded us of the (unannounced) aims of cutting interest rates in the late 1980s, despite explicit board recognition that monetary policy needed to be tightened, not eased. Nemisis came when cash rates had again to be raised, this time very substantially, leading to the early 90s 'recession we had to have'.

3. Now we have moved to a 'no comment' or 'don't mention the war' in which the RBA has let it be known cash rates are likely to be stable for some time. Since the housing boom suggests the next move in interest rates is likely to be up, the Australian dollar is again moving up.

In short: no consistency of purpose, confusing changes of approach, and further squeeze on exporters and those domestic companies struggling to compete against imported products and services. Verdict - 'failure, a weaker economy, not a stronger economy, and confusion.

The current RBA management will no doubt say 'Sir Harold Who?' and 'Henry Who?' should this Blog ever come to their attention.
Yet Sir Harold's advice remains the gold standard of monetary policy, and the mistakes of his sucessors RA 'Bob' Johnstone and Bernie Fraser should resonate with Glenn Stevens and other current senior officers who were watching and advising in the late 80s and early 90s.
Maintaining a clear focus on low goods and services inflation and a viable industry structure, and to lean into excessive house price inflation, requires additional policies.

* A variable tax on capital inflow to tame the excessive Australian dollar, as argued here in January 2013; and
* A pro-cyclical bank prudential capital ratio regime in which bank lending is reduced as house prices rise.

Without these additional policy 'instruments' , RBA governors will simply lose credibility and 'clients' will remain confused about the gameplan being followed.

Not a good look, and not a good outcome for the 'clients' - which means the rest of us Aussies, especially who do not have highly generous salaries and wonderful defined benefit superannuation schemes.

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