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The Reserve Bank of Australia needs to be congratulated for publishing research which implicitly confirms that it made a mistake when setting monetary policy in the period mid-2017 to early 2019.
Not that the research explicitly says that, but the RBA Discussion Paper, Cost-benefit Analysis of Leaning Against the Wind, written by Trent Saunders and Peter Tulip, makes the powerful conclusion that by keeping monetary policy tighter in order to “lean against” the risk of a financial crisis, there was a cost to the economy that is three to eight times larger than the benefit of minimising the risk of such a crisis eventuating.
The costs to the economy includes lower GDP growth and higher unemployment, that lasts for at least for several years.
A few terms first.
According to the Saunders/Tulip research, “leaning against the wind”, a term widely used in central banking, is “the policy of setting interest rates higher than a narrow interpretation of a central bank’s macroeconomic objectives would warrant due to concerns about financial instability”. In the RBA’s case, the “narrow interpretation” of the RBA’s objectives are the 2 to 3 per cent inflation target and full employment.
In the context of the period since 2017 and despite the RBA consistently undershooting its inflation target and with labour underutilisation significantly above the level consistent with full employment, the RBA steadfastly refused to ease monetary policy (cut official interest rates) because it considered higher interest rate settings were appropriate to “lean against” house price growth and elevated levels of household debt.
In the space of a couple of months, the rhetoric on the economy has gone from strong to weak.
Curiously, both assessments are wrong.
The economy was actually weak during the first half of 2019 and, if the leading indicators are correct, late 2019 and 2020 should see a decent pick up in economic activity.
It is not clear what has caused this error of judgment and the about face from so many commentators and economists, including importantly the Reserve Bank. A level-headed, unbiased look at economic data confirms that in late 2018 and the first half of 2019, the economy was in trouble. There were three straight quarters of falling GDP per capita, house prices were diving at an alarming rate, there was a rise in unemployment, wages growth remained tepid and low inflation persisted.
These are not the dynamics of a “strong” economy.
Only now, in the rear view mirror look at the economy, are these poor indicators gaining favour, leading to generalised economic gloom.