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Fiscal vs Monetary Policy: RBA Independance and Inflation Target not Sacrosanct? Chris Joye; Inflation targeting facing unprecedented challenge. Can the Reserve Bank of Australia abandon inflation target?
Topic Started: 3 Aug 2011, 10:16 AM (6,285 Views)
Sherlock
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Link -- http://christopherjoye.blogspot.com/

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Will the RBA drop its inflation target? We find out this week...

Terry McCrann correctly calls it the RBA's, and Glenn Stevens', moment of truth. This is how ICAP's Adam Carr describes the situation:

"Two back-to-back increases in core inflation of 0.9 per cent would ordinarily lock in a rate hike this week (RBA decision, Tuesday 1430 AEST) – and if I thought that we lived in a sane world, that would be my call. But I don’t think we live in a sane world. We live in a world where some board members stubbornly refuse to acknowledge that inflation is on the march, despite very clear supporting evidence. We live in a world where, despite two of our largest retailers posting solid sales growth and record sales, people talk about the retailing recession. We are in a world where the earth is flat!

So my formal forecast for this week is: I have no idea. I’m in a position where I simply can’t call what the RBA will do. Will the US default? I doubt it. Will the board hold off because of it? Possibly. Add it to the retailing recession and Australian’s deflation problem. As I discussed last week though, it doesn’t really matter. There is no point in being a hero and punting on this meeting when the market is still pricing in a rate cut (10 per cent) by year-end. That has paid well so far, thankfully, and I’d keep on it. I would look to that and 2012, which has even higher probabilities of cuts priced in.

Now if this kind of lunacy is indeed the majority view on the board, then we won’t be getting a rate hike this week. The problem is that it’s impossible to know exactly how popular the retailing recession/no inflation view is. We know the RBA aren’t fans. But they appear to have been rolled by board members who seem to prefer the whispers of the club, the grapevine and anecdote, to hard analytics. So who knows what the view is? I mean in June, strong domestic demand, high inflation, a surge in upstream prices pressure, low unemployment and strong global growth wasn’t sufficient to see them hike. It could be that it’s not sufficient at this meeting either or any other meeting for that matter."

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Four reasons why the RBA might not hike today...

As you know, I think they should hike, and I am absolutely confident that the correct policy response is to hike. But why after two consecutive strong quarterly core inflation prints might the RBA choose not to hike today? If they don't hike, don't be fooled into thinking they are dovish. They are not. So there are a few credible reasons regarding the delay:

1/ The RBA wants to prepare the community for a hike in September, and the 100 page Statement on Monetary Policy, which will contain its new inflation forecasts, provides the Bank with the perfect opportunity to do so (by upgrading its inflation projections out to 2013);

2/ Recent financial market volatility (US debt crisis), and the fact that nobody expects them to hike. The RBA is fond of telling us that it likes to smooth financial market expectations (why I am not sure), and avoid surprises (November last year anyone!). The release of the Statement on Monetary Policy, and the short statement today, gives the RBA a chance to bring the financial markets along with it in anticipation of the next hike. (But haven't they been doing this since March, and don't they lose credibility every time they change their mind?);

3/ Possibly the challenges associated with substantial Board renewal. Two long-serving Board members have recently departed, including one noted hawk, and it will likely take some time for the RBA to convince the two new Board members of their world view and the inflation risks associated with it; and

4) The RBA is no longer a genuine 'inflation-targeting' central bank, and is being compromised by an intrinsically dovish and conflicted Board dominated by private sector representatives that are adversely affected by higher rates (and/or currency). This means that the RBA is more likely to accept 3-4% pa inflation outcomes if economic growth and employment are sub-par.

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ICAP: RBA to fudge inflation target

"For mine this is a fairly critical meeting though. Should the RBA Board fail to hike rates today, following two back to back increases of about 0.9% on the cores, then I think we should take that as a fairly strong signal that the inflation target has been massaged. We know that global growth concerns or global debt concerns or other concerns are not going away. These fears can be used at every meeting. They will be a constant feature, they were a constant feature through strong growth outcomes last year. The word of the moment has to be ‘concerns’. The key question for the market is whether never-ending ‘concerns’ now mean the Board will tolerate higher inflation. I think we’ll find out today. Such a move would be more consistent with other Anglo central banks who have clearly either dropped inflation targets (eg the BoE) or are at least willing to accept a higher and as yet unannounced target over the forecast horizon ,in order to address other issues - i.e. strong currency in the case of the RBNZ and BoC."


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RBA loses credibility with financial markets

After six months of 40% upside misses on core and headline inflation, the RBA today told us that its Board "remains concerned about the medium-term outlook for inflation...and considered whether the recent information warranted further policy tightening." It will very likely reveal inflation forecasts on Friday that are either at the top of, or above, its acceptable 2-3% target range.

Yet after months of conflicting forecasts, statements, and jawboning from the RBA, the financial markets have priced in nearly two full rate cuts (or 40 basis points worth) following today's decision to hold. As a further challenge for the RBA, it has chosen to use 'market pricing' for future interest rates as the basis for its inflation forecasts. It is hard to see how this will continue to be possible given that the inflation forecasts will probably be even more grave than the last iteration, which assumed two future rate hikes (as opposed to rate cuts). In this regard, it is possible the RBA will dump its market pricing assumption and opt for something else.

The chart below suggests that the RBA has lost some control over interest rate expectations. As Ricardian Ambivalence correctly notes, the financial markets look to no longer either believe the RBA's inflation outlook, or that it will respond to that outlook. This is a worrying new development.

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ICAP calls RBA going the way of the Bank of England

So it starts...Market starting to talk about the RBA dropping its inflation target. From ICAP's Adam Carr:

"So they remain concerned about the medium-term outlook but clearly are not prepared to do anything about it – indeed, I would note that lending rates have come down in a sort of de facto rate cut.

How the RBA balances this with the lower growth profile will be interesting. The point about year-ended core CPI remaining consistent with the target is just absurd with the six-month annualised rate at 3.6 per cent – but that’s where we are at.

As I mentioned this morning, the failure of the RBA to hike indicates to me that the Board is now willing to accept higher inflation outcomes. I don’t think they’ve dropped the target per se, but rather moved it or pushed it out. It seems to me that, informally at least, the target is higher. Where that is I don’t know.

Will they act if year-on-year core CPI pushes through 3 per cent? 3.5 per cent? Knowing the new trigger point is not easy. Certainly 3.6 per cent annualised wasn’t high enough, and it’s worth noting the Bank of England’s analytics at this point. They’ve been talking down or looking though inflation for years now, finding one excuse after the next to keep rates low. I think the RBA has taken a big step toward that path today.

Bottom line, the CPI is no longer the key guide post to near-term or perhaps even medium term policy, I suspect. That box has already been well and truly ticked.

My guess is that the industry representatives on the board have no intention of hiking rates and I haven’t changed my view on that front. At the end of the day if back-to-back core CPI prints around 0.9 per cent can’t move the board, then, to be honest, I really don’t know what will."
Edited by Sherlock, 3 Aug 2011, 10:18 AM.
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raveswei
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Why Chris Joye wants rates up?
http://popping-bubble.blogspot.com/

Thinking of an Australian property speculator (PI):
Inaction = missing opportunities.
Missing opportunities = losing.
Too much thinking = inaction.
Thinking = missing opportunities.
Therefore thinking = losing.

disgraceful little man Frank Castle owes a house to Salvation Army

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Shadow
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Evil Mouzealot Specufestor

Of course the RBA has modified its inflation target. That's the obvious and correct response to the current environment. Inflation targeting is not one of the RBA's primary objectives. Inflation targeting is just a mechanism (one of several) that the RBA has sometimes used (since 1993) to achieve its primary objectives, being...

1. The stability of the currency of Australia
2. The maintenance of full employment in Australia
3. The economic prosperity and welfare of the people of Australia

(http://www.rba.gov.au/about-rba/our-role.html)

So inflation targeting is just a mechanism that the RBA sometimes uses to meet those primary objectives. Inflation targeting itself is not the objective. As we saw in 2008, the RBA started slashing rates with inflation at 5%. The RBA raised rates over and over again, supposedly to cool inflation, in the years and months leading up to 2008. But despite all those rate hikes, inflation kept on rising to 5%, mainly because that inflation was caused by external forces that the RBA has little control over. Those RBA rate hikes had negligible effect on inflation, apart from strengthening the AUD which would have put mild downwards pressure on some forms of imported inflation. So inflation was well outside the RBA target at 5% when the RBA started slashing rates in 2008. At that time, the RBA members were more interested in ensuring they met their most important two objectives…

- Maintenance of full employment in Australia
- Economic prosperity and welfare of the people of Australia

Those two objectives will always come first, for the RBA or any other central bank. Look at the UK or USA – inflation is rampant there and in many other countries, but interest rates are practically at zero. People (voters) come first, not inflation targeting. Any central banker who forgets that will soon find himself out of a job.

Inflation fell in 2008 due to a reversal of the same external pressures that caused it to rise.

The RBA are virtually powerless to control imported inflation using interest rates. They will do lots of jawboning and keep on telling us about the dangers of inflation, and tell us that inflation targeting is a primary objective in itself. But it's not. At the end of the day they will allow inflation to run outside the target range if keeping inflation inside that range would prevent them from achieving their primary objectives (which in the current environment, it would).

People and jobs come first, before some arbitrary inflation target.
Edited by Shadow, 3 Aug 2011, 10:55 AM.
1. Epic Fail! Steve Keen's Bad Calls and Predictions.
2. Residential property loans regulated by NCCP Act. Banks can't margin call unless borrower defaults.
3. Housing is second highest taxed sector of Australian Economy. Renters subsidised by highly taxed homeowners.
4. Ongoing improvement in housing affordability. Australian household formation faster than population growth since 1960s.
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Catweasel
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Catweasel laugh. Who a care what a Chris the Joye think anymore? It supposed to be a barometer of the highest precision, but in a reality it just a self the serving squire for the hire. In the hypothetical mouse revolution, a Chris the Joye be a thrown to the lions.
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Sherlock
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Catweasel
3 Aug 2011, 11:11 AM
Catweasel laugh. Who a care what a Chris the Joye think anymore? It supposed to be a barometer of the highest precision, but in a reality it just a self the serving squire for the hire. In the hypothetical mouse revolution, a Chris the Joye be a thrown to the lions.
Quelle surprise -- Mr Weasels contribution, is another personal attack!!
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Shadow
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Evil Mouzealot Specufestor

Inflation is Global

Quote:
 
Inflation is global

Posted on July 30, 2011 by Ricardo

A lot of talk surrounding the high Q2 inflation print has been about the extent to which it was the result of a number of once off factors, and as such can be ‘looked through’.

Apart from the fact that the RBA has told us the measure of inflation they prefer (the 2q average of the trimmed mean, which is 3.7%y/y AR), and that the best thing a Central Bank can do to stabilise inflation expectations (and hence inflation) is to pick some metric and stick to it, I think it’s worth looking at global inflation to see if the Australian inflation pulse is markedly different from what we’d expect, given peer inflation.

By no means is this a new idea: RBA Board member and ANU academic Warwick McKibbin has spoken about this a number of times, and the ECB has published research on the subject, which concludes that about 60% of the inflation impulse is global.

As you’d expect, given that the core measures the RBA prefers are also high, the pace of headline inflation looks about right, given peer inflation. That is, the trimmed mean and the weighted median are probably accurate. This shouldn’t come as a surprise, given the amount of work that’s been done on the question.

Posted Image

The above chart shows that the standardised rate of Australian inflation is just about where you would expect given peer inflation (note, I removed the GST changes in 2000).

The nations I have used are somewhat disparate, however they are the ones for which the RBA publishes inflation rates – and I figure that the RBA picked them for some reason.

To make the various national inflation data more comparable, I subtracted the mean and divided by the standard deviation for each national series — thereby allowing for different inflation targets and inflation volatility among the members (the USA, Japan, EU, UK, South Korea, Taiwan, Hong Kong, NZ, and Singapore).

I also split the groups between our Developed Market peers (the USA, Japan, EU and UK), and our Asian peers (South Korea, Taiwan, Hong Kong, NZ, and Singapore).

Apart from the fact that the acceleration and level of Australian inflation looks pretty right given the acceleration and level of inflation in our peers, I note that this was also the case in 2007/8. So, in this important way, the present acceleration in inflation is just like 2007/8.

I find this worrying, as the 2007/8 inflation surge was both unusually coordinated, and unusualy sharp. If it happens again, and there’s no GFC to help central banks out, policy is going to get diabolical (just think how difficult it would have been to get inflation back to 2% if there were no GFC).

Posted Image

Finally, I think it is interesting to note that the cross market correlation of inflation has increased over the past ten years. The above chart shows the rolling 5yr correlation between Australian inflation, and the three global inflation measures I showed above (the DM median, Asian median, and All markets median).

What’s this all about? I suspect that global output gaps are now playing a much larger part in the initial inflation impulse.

For the (broken) North Atlantic nations, they can probably afford to ignore this inflation surge, as the real wage loss to workers is a larger concern. Their slack labour markets mean there is low risk of second round inflation.

In Australia, we don’t have that luxury (note, it’s the luxury of starting in a lousy position). We have a tight labour market and wage growth that is already at the limit of what is consistent with the RBA’s 2% to 3% inflation target, given weak productivity growth.

Thus, the RBA probably cannot afford to tough it out. What if they are right about the mining boom? Then they’ll be starting with inflation at 2.75%y/y and trying to keep it at that level through a huge growth surge.

That’s both a herculean task, and bad place to start!

Given the above, I suspect that the recent surge in Australian inflation is probably not about floods, or cyclones (or a stupid banana quarantine laws). Australia’s inflation outcomes are about what you’d expect given peer inflation outcomes.

Fast growth in Asia appears to be a part of the explanation for the global inflation surge. Asia is exporting inflation as their fast growing economies press against global capacity constraints. Another way of saying this is that Asia is transferring real resources away from us, by bidding up their price – and that we take a real pay cut as a result.

On net, Australia is a beneficiary of this surge – via the terms of trade – so the correct policy response is relatively clear — to tighten monetary policy.

Unfortunately, that hurts those who are not direct beneficiaries, but then, that is all part of the adjustment process… and in the long run it’s better than accommodating inflation, and having to wrestle it back later by inducing recession.
1. Epic Fail! Steve Keen's Bad Calls and Predictions.
2. Residential property loans regulated by NCCP Act. Banks can't margin call unless borrower defaults.
3. Housing is second highest taxed sector of Australian Economy. Renters subsidised by highly taxed homeowners.
4. Ongoing improvement in housing affordability. Australian household formation faster than population growth since 1960s.
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Catweasel
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Sherlock
3 Aug 2011, 11:16 AM
Quelle surprise -- Mr Weasels contribution, is another personal attack!!
Catweasel laugh. It the respect a zealot's be a loyal to its spiritual master. But zealot need a remember, how the loyal and a benevolent a master to the zealot?
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Black Panther
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Very High Inflation is here for the next decade at least.

It is the natural consequence of all the money printing in the Anglosphere.

The RBA understands this.

Bears who dream of massive deflation are sleeping again.

Any monies sitting in bank accounts is effectively being reduced as each month goes by due to high inflation.

As for prices falling (including Real Estate), think the opposite, inflation will ensure prices go up.

My advice to the bears is as follows re any monies you have in the bank.

Dont do this ...

"One senior investment banker is more blunt: "People are scared that the government doesn't know what the fuck it's doing." He tells a story about an acquaintance who took out €30,000, wrapped it in a bag and stashed it in his garage. "The bag had previously had some food inside," he says. "So it attracted rats, who ate the notes."

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raveswei
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Quote:
 
Of course the RBA has modified its inflation target. That's the obvious and correct response to the current environment. Inflation targeting is not one of the RBA's primary objectives. Inflation targeting is just a mechanism (one of several) that the RBA has sometimes used (since 1993) to achieve its primary objectives, being...


But this is a new era of low interest rates (bulls use this argument to defend house prices)
Increase in targeted CPI/IR contradicts this assumption. It seems that house prices are doomed what ever happens

http://popping-bubble.blogspot.com/

Thinking of an Australian property speculator (PI):
Inaction = missing opportunities.
Missing opportunities = losing.
Too much thinking = inaction.
Thinking = missing opportunities.
Therefore thinking = losing.

disgraceful little man Frank Castle owes a house to Salvation Army

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Lefty
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People and jobs come first, before some arbitrary inflation target


Well said Shadow - couldn't agree more.
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