The Experts

Three other heterodox thoughts on the RBA

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First, the RBA's reference to a forecast unemployment rate of 4.5 per cent by mid 2013 is apparently a new innovation (Paul Bloxham and Kieran Davies pointed this out to me). So why include it, especially when you are near-100 per cent certain to get the forecast embarrassingly wrong, with the probabilities tilted strongly in favour of hitting it by the end of this year?

The answer is pretty obvious to my mind – the RBA is setting a non-inflationary rate trigger. The most important variable it uses to forecast inflation is unemployment. But the issue, as I observed yesterday, is that the RBA might face some lowish core inflation prints at the same time as unemployment is rapidly trending down, and wages rising. The seemingly absurd 4.5 per cent unemployment rate forecast in mid 2013 gives the RBA a target that it can use to prospectively rationalise a rate hike (that is, “Oh dear, the economy's capacity constraints are much worse than we last forecast!”).

The second thought that jumps to my mind is this. The RBA is basically saying today that market pricing of just one further rate hike was well wide of the mark. By using market pricing, and getting forecast outputs with core inflation at the top of the target for the final two years of the horizon, and GDP running way above trend for a sustained period, the RBA is telling us that it is going to hike more than the market thinks if its central case proves out. If the RBA's central case is going to present so many policymaking challenges, and rate changes today don't have their full effect for another two years (as the RBA's research shows), why wouldn't you start the process now? What is stopping hikes in March or April?

By the time March comes around, the RBA will have January unemployment data and Q4 wages. It will also have further visibility on February inflation and inflation expectations data from the Melbourne Institute. If the US and Chinese economic flows are still strong, and there is no evidence of additional European discord, can you really say that the current stance of monetary policy is appropriate for the outlook? I don't think so.

My final idea is this, which I have shared with one journo. There may be a little game theory at play here between the RBA and the government. You can make the case that there is every incentive for the RBA to hawk up as much as possible, and even fire off a rate hike, before the government's May budget. The more the RBA can scare the life out of Gillard/Swan about the spectre of a spate of rate hikes (prior to the 2013 election), the more likely we are to get austere fiscal policy outcomes. Lifting rates is never easy for a central bank, and it is tough to bring the community along. The RBA would ideally like fiscal policy to do some of the heavy lifting for it. At the very least, the government can do a lot more to lubricate labour supply (that is, via skilled migration). I would venture, however, that no matter how much sabre-rattling the RBA might be engaging in, its highest probability view of the world still implies a few more rate hikes even given more accommodating fiscal policy settings.

Published: Monday, February 07, 2011

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