A Series of Unfortunate Events
Phil Lowe’s ‘dangerous path’ versus Lars Svensson’s ‘foolproof way’
|Stephen Kirchner||Jun 16|
The minutes of the June RBA Board meeting dance around the issue of the Australian dollar’s outperformance since the current settings for monetary policy were adopted in March. The message from the minutes (ie, what the RBA told the Board) is that there is nothing to see here.
WIB helpfully put recent AUD outperformance against its peers in context by showing its relationship to central bank balance sheet expansion:
Australia’s relatively greater reliance on fiscal rather than monetary policy is having a predictable impact on the relative performance of the exchange rate. To be clear once again, this is not an argument against the use of fiscal policy in the current context. Fiscal policy could even do more. My contention is that monetary policy is not doing enough in response to what the Board minutes correctly describe as the biggest shock to the Australian economy since the 1930s. Even the AFR’s RBA watchers have noted the Australian dollar’s ‘unfortunate popularity,’ but have sought reassurance in Governor Lowe’s ‘dangerous path’ speech to the ANU Crawford Australian Leadership Forum last year, in which he said:
As the chart above suggests, there are clear exchange rate benefits from easing ‘a bit more than others.’ As for the dangers, yes, an exchange rate depreciation is inflationary, but that is not a risk in the current environment. A bit more inflation would reduce, not increase, macroeconomic risk.
There is a key difference in the exchange rate implications of a global monetary and fiscal expansion. In a global monetary expansion, countries get an exchange rate benefit from doing more rather than less. In a global fiscal expansion, those who expand the most, as Australia is at present, suffer an exchange rate penalty. The relative fiscal-monetary mix matters.
In contrast to Lowe’s ‘dangerous path’ concerns, policymakers should think more in terms of Lars Svensson’s ‘foolproof way.’ This is not to endorse his specific proposal for an exchange rate peg linked to a price level target. The broader implication of Svensson’s proposal is to recognise that monetary policy is not constrained by the ELB in the way Governor Lowe thinks. In principle and in practice, the central bank has the tools needed to hit a price level or inflation target. If only it has the will to use them.
The National Bureau of Economic Research says US recession began in February, bringing to an end the 128-month expansion that began in June 2009.