RBA moves inadequate

The Reserve Bank has cut interest rates to zero and is intervening in financial markets to get the economy moving again.  Is it doing enough?

The best way to judge this is to compare the Bank’s objectives with its forecasts. By this standard, the announced policy measures have been inadequate.

The RBA’s main objective is to keep inflation between 2 and 3 per cent.  Despite the stimulus, inflation is projected to reach only 1.5 per cent in two years’ time.

Monetary policy is also meant to maintain ‘full employment’, which is estimated to mean an unemployment rate of about 5 per cent. However, the RBA’s cuts will not be enough to bring the unemployment rate below 6 per cent.

More aggressive policy would deliver better outcomes – in particular, lower unemployment and higher inflation.  It would bring us closer to our objectives.

So the RBA should do more.

What should it do?  There are many options.  The Bank’s asset purchases should be scaled up and broadened. Research finds that negative interest rates are effective.  The Bank should push the exchange rate down.  Prudential restrictions on lending (many of which had a flimsy rationale in the first place) should be relaxed.  And more.  My favourite is Milton Friedman’s suggestion of a ‘helicopter drop’ of money, which essentially means tax cuts financed by selling bonds to the central bank.

The prudent approach is to do a bit of everything.  Because we are in unfamiliar territory, there is uncertainty as to which instruments will work the best — or even whether they will work at all.  That is an argument for trying them all, not for trying nothing.

Announcing the RBA’s latest measures, Philip Lowe said “If there’s a case to do more then we will do it.”  He also said “Even with today’s policy decision, inflation is too low, and the unemployment rate is too high.”

If that is not a case to do more, what is?

This is an edited extract of an opinion piece published in the Canberra Times as RBA needs to do more to boost economy