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The monetary policy galahs are squawking their usual lines about a strong labour market preventing the RBA trimming rates next month, but Michael Pascoe argues the RBA’s integrity will be open to question if it doesn’t cut.
The labour market is actually saying the Reserve Bank has been woefully wrong.
“You had one job,” as the saying goes, a job of great importance to the commonwealth’s welfare, of crucial importance to the precarious welfare of hundreds of thousands of people. You wouldn’t want to get it wrong.
All the more so when your reputation is on the line, when you’ve been very publicly defending your performance of that job for months on end, assuring the nation you know what’s best.
In such circumstances it is very difficult to admit you’ve been wrong for all those months, that you’ve caused unnecessary pain and suffering. It’s very tempting to prevaricate, to stick to your wrong course, or at least to try to slide away from that course rather than own the mistake and deal with it smartly.
But that makes for a bigger mistake. Getting something wrong is a matter of competence. Not owning the mistake is a matter of integrity.
It is the Reserve Bank of Australia’s integrity that is open to question when it meets next month.
Monetary policy
Monetary policy is a very inexact science, an inevitably clumsy art given its blunt instrument. Mistakes are inevitable.
Integrity, though, having the ticker and conscience to recognise and own a mistake, is a matter of character.
The problem facing the RBA staff and board is that, however they spin it, trimming rates next month will be an overdue admission of being wrong about the labour market and inflationary pressures.
The kindest interpretation of the mistake is that the RBA leadership is relatively inexperienced at the sharp end of monetary policy and thus fell captive to “the model” – the projections spat out by the RBA’s computers based on old data.
A flawed model
in November, the RBA’s model told the Governor she needed an unemployment rate of 4.5 per cent by the end of this year and ever after to get the trimmed-mean inflation measure down to 2.8 per cent. The model, based on old data, believes the NAIRU (the non accelerating inflation rate of unemployment), is 4.5 per cent.
This, demonstrably, is horseshit. Inflation has been consistently falling, not accelerating, with unemployment around 4 per cent or lower for the past two years.
It’s a little simplistic but not wrong to say an unemployment rate of 4 per cent is a DIRU, a decelerating inflation rate of unemployment.
So bad is the model the RBA has been relying on that it spat out a prediction of 4.3 per cent unemployment for December. Duh, actually 4 per cent, according to the ABS on Thursday.
As every wannabe computer modeller should know, “garbage in, garbage out”.
The bank and the federal government have been playing silly buggers with language when it comes to their desire for higher unemployment. Talk of the NAIRU is out of fashion. “Full employment” sounds so much nicer, but the RBA is fibbing when it pretends it knows what full employment is other than a euphemism for NAIRU. And, as demonstrated, the RBA does not know what that is.
RBA track record
This is by no means the first time the RBA has proven its uselessness when it comes to understanding the labour market and its links with inflation. It’s a uselessness not limited to our central bank, either.
A friend with an eye for such things provided a 1998 quote from economics journalist Samuel Brittan:
“Estimates of the natural rate of unemployment are not constants of the universe. Most attempts to estimate them embody what Friederich Hayek called in his Nobel Prize address ‘The Pretence of Knowledge.’ They do not provide a basis for deliberately slowing down an economy when, as in the US at present, there is no sign of inflation….”
Outdated text books and models
The RBA and several of the more obvious galahs in the monetary policy game have been suggesting the “tight” labour market is a barrier to trimming interest rates. They continue to do so despite all the evidence to the contrary, and only outdated textbooks and models are in their favour.
The inexperienced RBA leadership – not one of the top three has ever been involved in making the big call of reversing monetary policy – may lack the cultural memory of the last time the bank got its NAIRU fixation seriously and painfully wrong.
They’re not alone. Much of the commentariat has trouble dealing with history as ancient as last decade.
Just 10 years ago, trimmed mean inflation was around the mid-point of the RBA’s target range, with unemployment at 6.1 per cent. The inflation rate then started falling, dropping below the target range in early 2016 and staying there until COVID. At the same time, the unemployment rate was falling, down to 5 per cent in December 2019.
The cash rate was trimmed to 1.5 per cent in August 2016 and stayed there for nearly three years despite all the evidence of having a DIRU and weakening economic growth. By the time the RBA started trimming rates in June 2019, it was too little, too late, to battle the surplus-obsessed federal government. And then came COVID.
Already too late
As previously argued here, the RBA should have cut its cash rate in November. Pretty much all the data since then have confirmed that sitting pat, believing its dud model, was a mistake.
Face or facts? Falling inflation makes a compelling case for Reserve Bank to cut rates today
By their very nature, models are incapable of picking up a shift in the NAIRU. The data they are fed only reflect the change long after it has happened after the wounded have been bayoneted and the innocent blamed.
This is why the RBA’s integrity will be on show at the February meeting.
The Governor can stick up her hand and say, yes, the bank has been wrong and the cash rate must be trimmed.
The blow can be softened with a couple of the usual phrases, “acting out of an abundance of caution” and “with the benefit of hindsight”, but the necessary and overdue cut next month will effectively be an admission of making a costly mistake.
There already is a question about competence in the way the present RBA board and management acquiesced to a dubious Treasury reinterpretation of its mandate. As far as it is possible to understand RBA speak, the target of the CPI being in the range of 2 to 3% over time has been replaced with an underlying inflation measure being 2.5%.
Now, anything less than admitting its NAIRU mistake will question both the bank’s competence and integrity.
Michael Pascoe is an independent journalist and commentator with five decades of experience here and abroad in print, broadcast and online journalism. His book, The Summertime of Our Dreams, is published by Ultimo Press.