RBA’s bond taper underscores its lack of ambition, not its genius

Open economy crowding-out effects point to excessive reliance on fiscal policy

Last week in this space, we noted the underperformance of the long-end of the Australian bond market and the fact that the RBA’s policy actions in March have left virtually no mark on the Australian dollar exchange rate. This is attributable, at least in part, to Australia’s relatively good performance in suppressing the pandemic, which is all to the good.

However, it is also consistent with open economy crowding-out effects from an excessive reliance on fiscal policy at the expense of monetary policy. This is not intended as a criticism of the size or scope of the fiscal policy measures, which are necessary, although one can quibble over their design. Fiscal policy could even do more. Rather, it is a criticism that monetary policy is not doing enough. It is no accident that Australia’s fiscal policy response is one of the largest of comparable countries. The RBA has been trying to kick the demand management ball into the government’s court since well before the pandemic.

Last week, analysts were cheering the strong demand for the AOFM’s largest ever bond syndication, the new 1.00% 21 Dec 2030 bond, not least from offshore investors, who took up 46% of the issue. While a vote of confidence in the Australian economy, the strong demand is also symptomatic of the fact that Australia is the highest yielding AAA-rated sovereign, attracting foreign capital inflow and putting upward pressure on the exchange rate (all else equal), exactly what you would expect from a relatively large fiscal stimulus and a minimalist monetary policy response.

Analysts have also been cheering the taper in the RBA’s bond buying to a pace of around $500 million per week, on the basis that the RBA is achieving its target cash and 3-year bond rate while having to do little bond buying. But this only underscores the RBA’s lack of ambition, not its genius. As we noted last week, the RBA’s interest in quantitative approaches to monetary policy is limited to control of the short-end of the risk-free rate curve. It does not see monetary policy operating through a base money channel. To call it ‘money printing’ is completely inaccurate.

WIB’s de-composition of the AU-US 10-year bond yield spread (below) shows that Australia’s underperformance is driven by the real yield differential. That’s not a bad sign for the Australian economy, but the continued relative weakness in inflation break-evens is consistent with the idea that Australian monetary policy is not doing enough, with fiscal policy carrying the burden. Again, this is not a criticism of the fiscal measures, but of the RBA’s failure to do more. When the fiscal policy measures roll-off at the end of Q3, along with the loan holidays, the Australian economy will fall off a fiscal cliff, with little indication the RBA is willing to take up the slack, although it may well be forced to do so.

There is a notable contrast with the US experience. As Peter Ireland noted in a paper last week, under the leadership of Jerome Powell, ‘the FOMC is firmly committed to a monetary policy strategy that avoids the most serious mistakes that account for the astounding severity and length of the Great Depression.’

Having recently failed to reiterate its inflation targeting framework following its strategy review, Peter advocates that the Fed adopt nominal GDP targeting by:

appending to its quarterly summaries of economic projections a graph that presents an official, multi-year target path for four percent annual growth in the level of nominal GDP.  Committee members could then describe their meeting-by-meeting monetary policy actions with repeated and consistent reference to that target path.

As Peter notes, this is consistent with the Fed’s existing statutory mandate. It would also be perfectly consistent with the RBA’s statute, although not the current joint Statement on the Conduct of Monetary Policy. The RBA should aim for a target path of at least 5.5%.

Last week saw the release of the April labour force numbers, which were dire enough, but as noted last week, understate the unprecedented magnitude of the downturn in the labour market. Perhaps the best indicator of what it happening in the labour market right now is the decline in hours worked, helpfully updated and normalised by Matt Cowgill at the Grattan Institute:

The collapse is unprecedented in the history of the labour force survey going back to 1978.

The wage price index confirmed that wages growth remained subdued at 0.5% q/q and 2.1%, a reflection of low productivity growth and low inflation expectations. Consumer confidence fared a little better, with a record 16.4% m/m rise following last month’s record collapse. It suggests consumers are looking through to the other side of the downturn.


ICYMI

Jessica Irvine wrote-up my recent report on the Australia-US productivity differential in long-run perspective in the SMH/Age.

I had an op-ed in the AFR on China’s threatened anti-dumping duties on Australian barley exports, noting that Australian barley producers were as much victims of Australian trade and industry policy as Chinese foreign policy. For further insight into the economics of dumping and the political economy of anti-dumping, see my Issue Analysis on the topic from 2013.