OPINION: The key to avoiding a re-run of the 1970s is the inflation expectation set by the Reserve Bank. Its communications have to improve.
As the Reserve Bank of Australia board convenes on Tuesday, it faces perhaps the most challenging set of circumstances since the establishment of independent monetary policy in Australia.
It took a decade for real rates to return to being above zero. In hindsight, the failure is obvious. A prolonged period of excessively loose monetary policy allowed expectations of high inflation to become entrenched, or “unanchored” – a long-dormant term you’re hearing more today. The consequences of inaction now would be the same.
It was surprised by strong March-quarter inflation despite inflationary pressures emerging in other countries months earlier. And its first rate rise, during the election, was a too-modest 0.25 of a percentage point when rates elsewhere had already risen far higher. It’s as though the bank has had to be dragged kicking and screaming into taking inflation seriously.
Today, real interest rates remain strongly negative – with inflation well above 5.1 per cent and the interest rate on exchange settlement balances at just 0.75 per cent. That means rates can rise substantially while still remaining stimulatory.If, conservatively, we imagine underlying inflation – excluding temporary factors – is running at about 3 per cent, then real rates can rise by more than 2 percentage points and still be negative. We need to get a move on.
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