The Reserve Bank of Australia Board decided to increase the official cash rate by 50 basis points to 0.85% at its June meeting. This was a larger increase than the market was expecting, with market expectations ahead of the meeting more or less evenly divided between either a 25 or 40 basis point move. It is the largest increase in the cash rate since February 2000.
The RBA also increased the interest rate on Exchange Settlement balances by 50 basis points to 0.75%, maintaining the 10 basis point margin below the target cash rate.
The RBA noted inflation pressures, both globally and domestically, and said that ‘given the current inflation pressures in the economy, and the still very low level of interest rates, the Board decided to move by 50 basis points today. The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead.’
It is noteworthy that all of the inflationary pressures cited in the statement were supply-side issues. The RBA said that as ‘supply-side problems are resolved and commodity prices stabilise, even if at a high level, inflation is expected to moderate. Today's increase in interest rates will assist with the return of inflation to target over time.’
Zac Gross and Andrew Leigh have released into the wild their paper on Assessing Australian Monetary Policy in the Twenty-First Century. I get a few mentions and the inclusion of the counterfactual exchange rate paths was my suggestion, if memory serves. The most striking conclusion from the paper is that the optimal cash rate turns negative during the 2016-19 period in which the RBA was leaning against the wind by holding the cash rate steady and talking up expectations for future tightening even as inflation remained below target:
Source: Gross and Leigh (2022)
It is also noteworthy that even the optimal policy rule only gets trimmed mean inflation to the bottom of the target range. The model estimates an additional 2.1 percentage point years of unemployment, or the equivalent of 270,000 people being out of work for a year from the deviation in the actual cash rate from an optimal policy rule. The results are consistent with the very unfavourable cost-benefit ratio found by Tulip and Saunders in their application of Lars Svensson’s LAW cost-benefit framework to the Australian data.
Way back in 2009, I highlighted the dangers of leaning against the wind in a paper for CIS at a time when the RBA was much more agnostic on the issue of whether monetary policy should lean against asset prices and credit growth. Suffice to say that ideas have consequences. Also, as Ronald Coase might have pointed out, I am grossly under-remunerated relative to the potential value of my policy advice.
One of my suggestions to Zac and Andrew was that they also simulate the period from March to November 2020. The zero lower bound does not invalidate a simulation based on the cash rate because the RBA’s own actions imply that it was a not a binding constraint during this period. While the RBA initially suggested that 0.25% was an ‘effective’ lower bound, it subsequently lowered the cash rate target to 0.10% and effective cash traded lower still with the ESA balances rate set to zero. At the very least, the RBA had 15-25 basis points it chose not to use between March and November 2020, even if you think it couldn’t take the cash rate negative. You can’t argue that the zero bound is a binding constraint if you don’t actually go there.
If the optimal cash rate was negative during the 2016-19 period, it would have certainly turned negative in 2020, implying large output and employment losses from sub-optimal monetary policy. While the RBA’s forward guidance backed by yield curve control would have been an offset to this, the deviation in the cash rate from the unconstrained optimal policy rule between March and November would nonetheless still be indicative of the losses due to the RBA pulling its punches in its initial pandemic response. Things get more complicated with QE from November 2020, but even then, a shadow rate could be applied to simulate the contribution of bond purchases.
APRA and ASIC won’t let us have nice things
Aleks Vickovich had a story about the long wait for Vanguard’s much-anticipated retail superannuation product. The story confirms that Vanguard has yet to secure a registerable superannuation entity (RSE) licence from the Australian Prudential Regulation Authority. This is despite the fact that Vanguard has previously been a retail superannuation provider, before it offloaded its retail clients to Plum Super fearing it could not compete with default super products. As it turned out, default super turned into some of the worst products in the market. The story also suggests Vanguard may not be the cheapest product in the market until it achieves scale, which will take more time still. The new product had previously been expected around the middle of last year. The timetable is now supposed to be before the end of this calendar year, which will make it a lost decade for Vanguard after it vacated the retail superannuation space around 2012.
In other ‘regulators not letting us have nice things’ news, Bloomberg ran a profile of Kalshi, a new(ish) CFTC-regulated, fully cash-collateralised prediction market we have pointed to in this newsletter previously. The story documents the considerable regulatory barriers faced by prediction markets, but also notes the role of Republican-appointed securities regulators in lowering some of these barriers. As the story notes, ‘that Kalshi prevailed was less a testament to Silicon Valley-style innovation than it was to persistent lobbying and legal wrangling.’ Kalshi’s success should not distract us from the fact that the US prediction market space is still well behind where it was in its heyday in the mid-2000s.
In Australia, the main form of prediction market contract, the OTC binary option, is currently the subject of a ban by ASIC. The product intervention order expires in October this year, but ASIC is now proposing to extend the ban until 2031! Not only would this effectively prevent innovation in the prediction market space in Australia, it will also preclude Australian investors participating in offshore prediction markets. While the ban only applies to retail investors, some overseas OTC binary options platforms have closed to all Australian clients as it is the easiest and cheapest way for them to comply with the ban. If Intrade or iPredict had not already succumbed to offshore regulators, they would now be off-limits to Australian clients. This is a good example of ASIC’s product intervention powers stifling potential innovation. If you wish to comment on the extension of the product intervention order, you can make a submission via Market.Supervision.OTC@asic.gov.au before 20 June. The intervention order is subject to a determination by the Minister. At the very least, ASIC should be encouraged to make an exemption for public interest prediction markets.
Nowcasting the US Q2 output gap
US May non-farm payrolls came in at 390k relative to our forecast of 330k, while the unemployment rate remained steady at 3.6% relative to our forecast of 3.5%, although as noted last week, we had the unemployment rate ticking-up on an unrounded basis relative to April. The May employment outcome allowed James Morely to update his nowcast of the Q2 US output gap at 4% relative to 3.8% in Q1, a historic high, although his model’s conditional forecast is that the US economy reverts back to trend by Q3 2023:
I still prefer the Mercatus NGDP gap as a measure of excess demand pressures.
Mark Zandi had a nice chart highlighting the post-pandemic shift in US consumer demand between goods and services. The implication is that measured inflation is the product of changing relative prices, rather than excess demand. Total spending in real terms remains consistent with its pre-pandemic trend:
ICYMI
Give me NIMBY or give me death: “I’m going to win or I’m going to die,” Mr. Richardson said. “It’s one or the other.”
Noah Smith tweets: