Working Papers

Betting on the RBA

Someone was betting big on the outcome of today’s RBA Board meeting:

a Centrebet regular, has staked just short of $30,000 on the Reserve Bank sitting on its hands.

If at 2.30pm the bank announces its board has decided to keep rates on hold, he will walk away with a profit of $21,000. If it puts rates up, he will say goodbye to $29,500.

‘‘He is very confident. He placed four separate bets, continuing to pile in as the odds went down,’’ said Centrebet’s Neil Evans.

‘‘Another punter staked $5000 on there being no change, another $3500.

‘‘It’s the house against the punters. I am hoping they don’t know something I don’t.’‘

They didn’t.

posted on 02 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The CPI and the RBA’s Backward-Looking Bias

I have an op-ed in today’s Canberra Times arguing for a monthly CPI for Australia (full text below the fold):

This lack of timeliness in compiling and releasing inflation data gives monetary policy a backward-looking bias.  Around 45 per cent of the changes in the official interest rate since 1990 have been announced at the Board meeting immediately following the quarterly CPI release.  During the 2002-08 tightening episode, 67 per cent of rate hikes followed this pattern, including every one of the six tightenings between May 2006 and February 2008.

Today saw the release of the TD Securities-Melbourne Institute Monthly Inflation Gauge, which rose by 0.1% in February, following a 0.8% rise in January and a 0.3%  rise in December 2009. In the twelve months to February, the Inflation Gauge rose by 1.9%. The trimmed mean measure rose by 0.1%, to be 2.0% higher than a year ago.  The gauge points to a 1% rise in the March quarter CPI for an annual rate of 3%.

As I note in the op-ed, the Melbourne Institute has stopped publishing the index numbers for the gauge, limiting its usefulness and going very much against the spirit of its creators and sponsors.  However, for those who need it, Annette Beacher advises the index number for February is 123.45.


continue reading

posted on 01 March 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Divergent Pricing for March RBA Board Meeting

Friday’s Reuters poll has 12 of 18 financial market economists expecting a 25 bps tightening, with the balance looking for steady rates.  March inter-bank futures are giving only a 49% chance to a 25 bp tightening, while iPredict is pricing a 67% chance of a rate hike.  I suspect interbank futures are closer to the mark.

I will be talking on Australian monetary policy on Bloomberg TV Tuesday morning AEDT.

posted on 26 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA and the Media

RBA Governor Stevens’ appearance before the House Economics Committee on Friday included this exchange with the federal member for Mayo:

Mr BRIGGS—Just on a slightly different track: On 2 November last year there was an article on the Lateline Business program about suggestions that the Reserve Bank executive selectively leaks the likely outcome of the board meeting prior to the board meeting. I guess the presenter summarised it best:

Certainly, there’s disquiet among market economists that the Reserve Bank is selectively briefing certain journalists in the lead-up to rate decisions. Many argue the practice undermines the board process.

I am just interested—did you see the report, and do you have a comment?

Mr Stevens—I did see the report. Apparently there were not too many selective leaks in February, because everybody was surprised, so I am not sure what to make of all this.

Mr BRIGGS—So, you—

Mr Stevens—No, people do not leak the outcome. For a start, the staff do not take calls from the media after the relevant internal meetings where we have come to the view of what we are going to recommend. That is usually on the Thursday morning; the papers go that night.  Secondly, we cannot be certain that the board will do what we recommend. It is a board of nine people, and I can assure you they are all of independent mind. People do not leak that information; in my experience the Reserve Bank never has leaked and, if I can help it, it never will.

Stevens is probably correct to argue that the outcome of the Board meeting has never been leaked outright, but that was not what the Lateline Business story was about.  The issue raised was whether the RBA backgrounded journalists to the point where they were much better informed about the RBA’s policy bias and therefore better able to call the likely outcome of the Board meeting.

There is evidence on the public record for the view that the RBA has engaged in this practice.  In a profile of former Governor Ian Macfarlane published in the AFR Magazine in 2001, a former RBA official is quoted as follows:

The Bank uses newspapers to manage expectations.  It’s a game the Bank manages very well.  Senior people talk to a small handful of the economics writers from the major papers on a strictly non-attributable basis.  I think it’s right to do this from the bank’s point of view, but not necessarily from a public policy view: accountability and a critical press are very important in this system.

That last sentence is the key issue in a nutshell.  My sense is that the RBA has now been subjected to sufficient heat over the issue that we won’t see another episode of this in future.  The test for the RBA will be whether there is a future recurrence of market speculation about RBA media backgrounding, despite the Governor’s denial.

posted on 20 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Endogenising the Inflation Forecast

RBA Assistant Governor Phil Lowe highlights an important change in the RBA’s technical forecasting assumptions:

For some years, it had been our practice to produce forecasts assuming that the cash rate remained unchanged throughout the forecast horizon. This approach had the obvious advantage of simplicity, but when the cash rate is a long way from its normal level, it is not particularly realistic.

So, in August last year we changed our approach. Since then, we have prepared our forecasts on the technical assumption that the cash rate returns towards a more normal setting over time. Our overall objective here is to provide the community with a general sense of how we think the economy is likely to evolve over the next few years and to do this we need to make realistic assumptions. Broadly speaking, the paths the staff have used have been similar to those implied by market interest rates at the time the forecasts were prepared. It is important to stress that this neither implies a commitment by the Board to the particular path used nor an endorsement by the Bank of the market pricing.

This is a welcome change.  It makes more sense for an inflation targeting central bank to forecast its own policy rate or to incorporate a market forecast for the policy rate and then base the inflation forecast on this projection.  This makes it more explicit that inflation outcomes are not exogenous under an inflation targeting regime.

There was also this endorsement of the macroeconomic benefits of increased labour market flexibility:

The good news is that this flexibility in employment relationships worked in limiting job losses in the economy. This has had obvious social benefits as well as supporting overall confidence in the community. Without this flexibility, it is likely that the outcomes would not have been as favourable.

posted on 18 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Consumers as Interest Rate Hawks

The February Westpac-Melbourne Institute Consumer Sentiment survey finds respondents expecting increases in mortgage interest rates in excess of 100 bp over the next 12 months.  While this is somewhat in excess of the tightening in official interest rates recently priced into the inter-bank futures strip, it is not necessarily inconsistent with market pricing.  Consumers are by now well aware that the official cash rate is not the only determinant of mortgage interest rates and that there is a trade-off between changes in mortgage interest rates and the official cash rate. 

Treasurer Wayne Swan continues to maintain that there is ‘no excuse’ for interest rate movements in excess of movements in the official cash rate.  If lenders were to have followed this advice in the past, then none of the benefits of lower funding costs from mortgage securitisation would have been passed on to borrowers before the onset of the credit crisis.  Moreover, any future improvement in capital market conditions could not be passed on to consumers, but would instead be hoarded by lenders with the Treasurer’s implicit blessing. 

posted on 11 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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The RBA’s 50th Anniversary Symposium

Today I attended the RBA’s 50th anniversary symposium.  The proceedings were not for attribution, but the papers have been published on the RBA’s web site.  The session on supply-side issues was a particularly welcome contribution to an area too often neglected by central banks, but one that is inescapably linked to the conduct of monetary policy.

posted on 09 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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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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No Free Lunch for Credit Conditions

The RBA has surprised the punditocracy by leaving the official cash rate unchanged, although financial markets had not fully priced a tightening.  The RBA’s decision is consistent with comments made by Deputy Governor Ric Battellino late last year noting that credit conditions had tightened by 100 basis points relative to changes in the official cash rate over the last two years.  He also noted that the tightening in lending margins had largely been in the area of business lending, not housing.

Today’s decision puts the bank-bashing by the government and others into proper perspective.  The RBA discounts lending margins in its setting of the official cash rate.  There are those who persist in believing that there is an interest rate free lunch to be had, if only the banking sector could be made more competitive.  Today’s decision shows that monetary policy is so carefully calibrated to prevailing credit conditions that any exogenous easing through increased bank competition would be quickly taken back via the official cash rate.  The RBA said so explicitly at the time of its August 2006 interest rate decision:

Compression of lending margins over recent years has contributed to a lowering of borrowing costs relative to the cash rate. This has meant that although the cash rate has recently been slightly above its average for the low-inflation period since 1993, interest rates paid by borrowers have remained below average.

Even Peter Martin is giving Westpac some love, so the message must be slowly sinking in.

posted on 02 February 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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RBA Tightening Expected on Tuesday

Financial market economists are unanimous in expecting a 25 bp tightening from the RBA at Tuesday’s Board meeting, according to a Reuters poll taken today.  February inter-bank futures are giving a 69% probability to a 25 bp tightening, while iPredict has an implied probability of 87%.  Markets seem to be underpricing a tightening relative to the punditocracy, perhaps reflecting the same concerns driving weakness in equity markets.

posted on 29 January 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Sentences You Won’t Read from the Reserve Bank of Australia

From today’s Reserve Bank of New Zealand intra-quarter policy review:

As growth becomes self sustaining, fiscal consolidation would help reduce the work that monetary policy might otherwise need to do.

This is more the RBA’s style (see if you can guess when the RBA said it before clicking here):

The purpose of my answer was to explain why it was wrong to claim that rises in interest rates were due to the stance of fiscal policy.

My answer in no way constituted an attack on the Government’s fiscal policy.

Governor Macfarlane was right to argue that fiscal policy was then irrelevant to inflation and interest rates.  But more recently, Governor Stevens has argued that fiscal stimulus has supported economic activity and that there is a trade-off between monetary and fiscal stimulus.  Just don’t expect him to spell out the implications of that logic in a policy announcement as candid as that from the RBNZ.


posted on 28 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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Core Inflation

The December quarter CPI to be released on Wednesday is seen at 0.4% q/q and 2% y/y, according to Friday’s Reuters poll.  This is somewhat higher than the 0.1% q/q and 1.7% y/y implied by the TD-MI inflation gauge. 

The trimmed mean is seen at 0.6% q/q and a steady 3.2% y/y.  The weighted median is seen at 0.6% q/q and 3.5% y/y, down from 3.8% y/y in the previous quarter.  It is noteworthy that despite a near two percentage point increase in the unemployment rate, core inflation was not reduced to an annual rate consistent with the RBA’s 2-3% target range during the recent economic downturn.

posted on 25 January 2010 by skirchner in CPI, Economics, Financial Markets, Monetary Policy

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RBA’s Kraehe Highlights Supply-Side Constraints

RBA Board member Graham Kraehe highlights the capacity constraints driving monetary policy tightening:

Asked if there was a risk of too much policy tightening choking off recovery, Mr Kraehe said the focus should be on price rises rather than supporting demand.

“The risk is more to cost pressure and inflation than it is to the demand side,” he said.

“Our unemployment has clearly now peaked. We’ve got increasing and continuing demand for employment in the resources sector that will put pressure on wages,” said Mr Kraehe, who is also chairman of Bluescope Steel.

“As an economy, one of the issues for us will be our ability on the supply side, whether it be on housing or the labour market, to supply enough resources to be able to take some of the pressure off cost inflation. Wages is one thing, housing another,” Mr Kraehe said.

posted on 22 January 2010 by skirchner in Economics, Financial Markets, Monetary Policy

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Inflation for the Long-Run

Jim Hamilton points to his Phillips curve relation, which is forecasting deflation over the near-term.  For the long-run, he suggests we should look to the fiscal theory of the price level:

The value of the new Federal Reserve liabilities ultimately will be determined by the long-term fiscal soundness of the U.S. government….Inflation is not something you should be afraid of for 2010. But what we need is a convincing commitment from the government to both near-term stimulus and longer-term fiscal responsibility in order to be assured that it’s not a concern over the next decade.

And that’s not what I’m seeing from the U.S. Congress.

Meanwhile, Thomas Frank contemplates an evil plot to stick it to the gold bugs: putting Fort Knox on eBay.  Not that it would work, but there is a certain irony in those who fear inflation taking refuge in the one real asset that is potentially the most vulnerable to a surge in supply from central banks and governments.

posted on 21 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Gold, Monetary Policy

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Did the US Treasury See the Inflation Nutters Coming?

I have a column in today’s Business Spectator arguing that the global debate about whether monetary and fiscal stimulus will prove inflationary reflects poorly on the credibility of policymakers.  One of the lasting effects of the discretionary policy responses to the global financial crisis may be the damage it will do to the credibility of monetary and fiscal policy frameworks.

David Merkel has updated the inflation expectations implied by US Treasuries, noting that ‘rapidly rising long-term inflation expectations indicate that the average investor does not trust monetary policy to succeed over the next 20+ years’.  At the same time, Merkel argues that since this outcome is already priced, it may be time to short US Treasury Inflation Protected Securities (TIPS).  The US Treasury may well be taking the inflation nutters for a ride:

there is a lot of demand for long TIPS.  If the US Treasury thinks it can get things under control, the rational thing to do is to stuff the long TIPS buyers with as much product as they can gulp before it becomes obvious that low inflation will continue because the government will soon balance the budget and pay down debt, as they did after WWII.

But Merkel also concedes that:

I don’t know which direction the US Government and Fed intend to go with policy.  They likely have no idea as well…if the US Treasury can’t get things under control, the long TIPS buyers will do well, as they have the most sensitivity to rising forward inflation expectations.

The enormous uncertainty created by the discretionary policy responses of governments to the crisis will weigh on economic activity, regardless of how these issues are ultimately resolved.

posted on 20 January 2010 by skirchner in Economics, Financial Markets, Fiscal Policy, Monetary Policy

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