Why the RBA might not have cut enough

by Matthew Smith | 19 Oct 2016

The Reserve Bank of Australia has not been open enough with its reasons for keeping the cash rate as high as it has kept it while the economy has been slowing, says Nicholas Gruen, Chief Executive Officer, Lateral Economics.

The RBA board made the decision this month to leave the cash rate unchanged at 1.5 per cent.

The Reserve Bank has not dipped as low as other central banks in Europe, Asia and in the United States in an effort to stimulate the economy here.

“We have invented a new economics text book, and this new economics text book tells you something different from what I learned and what is still taught at universities, which is that if your forecasts tell you have slack in the economy, and you have room to loosen policy, then you should. We’re not doing that,” Gruen tells a panel discussion during this month’s Committee for Economic Development of Australia’s (CEDA) “State of the Nation 2016” conference.

In October, the RBA noted that inflation is expected to remain low for some time given very subdued growth in labour costs and very low cost pressures elsewhere in the world. 

We have invented a new economics text book, and this new economics text book tells you something different from what I learned and what is still taught at universities.

“Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 has been helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this,” the RBA notes as part of the rationale for its October decision.

“Taking account of the available information, and having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time,” the RBA states.

But Gruen says there is a general consensus in Australia that the cash rate should have been cut more than the 1.5 per cent it’s reached.

“I happen to think we should [have cut further], but I don’t want to tell you I’m right and the RBA is wrong. What I’m saying is we’re not having the debate,” Gruen says.

Since the cash rates of central banks around the world have dipped into historically low and in some cases negative territory, academics and public policy experts have begun to question whether there are stimulatory benefits of cash rates at these levels, and whether Australia should start considering other more “unconventional” policy initiatives outside of moving the cash rate.

Gruen, who describes himself as a commentator, and is a widely published policy economist and advisor to cabinet ministers, says he would like to see the RBA support its decision with models explaining why it makes sense, “because in the traditional macroeconomic policy [context] doesn’t make sense… We should have a debate about this,” he says.

Source: Finsia