Misread Inflationary Signals and the RBA's Policy Conundrum
The ESA Victoria Branch invite you to join them for this professional development seminar, which will take place via Zoom on Thursday 27 July.
About this seminar
Australia is a small open economy, characterized by full capital mobility and a floating exchange rate system, where the interest rate is predominantly influenced in global financial markets. If the RBA or any central bank of a small open economy attempts to resist rate hikes while the US Federal Reserve or the European Central Bank increase their benchmark rates, the Australian dollar will depreciate, making the prices of imported goods and services in the CPI basket more expensive, subsequently requiring the RBA to raise the cash rate even further and faster.
The RBA has underestimated the importance of inflationary expectations, capital mobility, and the exchange rate variations. Many "hawk members" of the US Federal Reserve who advocate for lowering inflation through higher interest rates often choose their words very carefully after considering high frequency data on core and headline inflation, wages, the shape of yield curve, daily commodity prices, the Purchasing Managers' Index (PMI), and jobless claims. It is absurd to note that until very recently, Australia had only quarterly data for the Consumer Price Index (CPI), unlike most OECD countries that have had monthly CPI data for decades. The Australian Bureau of Statistics (ABS) only began publishing a monthly CPI indicator on October 26, 2022. How did the Reserve Bank of Australia (RBA) set the cash rate on the first Tuesday of each month (except January) relying on quarterly CPI data for so long? When did they ask the ABS to compile monthly CPI data?
The crux of the issue lies in the following simple issue: at present the US terminal rate and inflation rate are currently more or less comparable. In the past the Fed’s funds rate (equivalent to the cash rate in Australia) was cut only if it was above or equal to inflation, whereas in Australia, the cash rate is currently significantly lower than inflation (4.10% vis 5.6%). Due to the interest rate differential, the Australian Dollar has depreciated about 8% against the US Dollar over the past twelve months. In this seminar, we discuss how the RBA managed to get it so wrong. The lack of understanding regarding the lagged effects of cutting the cash rate on inflation over time, the yield curve inversion, and conflicting signals from the equity and bond markets further exacerbate the complexity of the rate-setting process.
About the speaker
Professor Abbas Valadkhani is currently affiliated with Swinburne University of Technology. He graduated from the University of Queensland in 1997 and has held full-time permanent positions at the University of Newcastle, Queensland University of Technology, the University of Wollongong, and the University of New England. He has published over 100 articles in reputable journals such as Energy Economics, Global Finance Journal, Energy Journal, Economic Record, Economic Letters, Economic Modelling, etc. His research on the cost of living holds significant practical implications in the field of public policy. In 2016, his research work, published in The Conversation and The Guardian, made a significant policy impact, prompting several parliamentarians to initiate an inquiry into how Australia's 'Big Four' banks set interest rates. This inquiry received extensive media coverage. During a Senate Committee inquiry, parliamentarians directly referenced his findings while questioning the CEOs of the 'Big Four' banks, leading to increased transparency and competition in the market. He is currently ranked among the top 5% of economists in the world by Repec.
