Conventional wisdom or hollow factoid?

On Friday we heard that the Governor of the Reserve Bank stated that he is prepared to raise the interest rate during an election campaign, contrary to received wisdom. This was actually two pieces of news for me, since I’d never heard about the received wisdom in the fist place.

I assumed this was my fault for not mixing enough with street-wise and well-connected types who know about these kinds of tacit imperatives, and resolved to make amends by looking into it. (Meanwhile, Nicholas Gruen has dealt with the more substantial issues relating to central bank independence.)

References in the last week to a taboo on increasing interest rates in an election year seem to have originated with John Edwards, chief economist of HBSC:

“Mr Stevens has broken the taboo on increasing interest rates during an election year,” he said.

While it seems that Edwards himself has introduced the word taboo into the discourse, the proposition he is putting goes back at least as far as this Lateline story in February.

Mr Stevens also rejected perceptions that the bank would not raise rates in an election year.

PHILLIP LASKER: Glenn Stevens also cleared up what he said was a common misconception his predecessor, that [sic] Ian MacFarlane claimed there was an unspoken tradition that interest rates aren’t adjusted in an election year. He said that the looming federal election would not prevent the RBA from acting if inflation picked up later this year.

The ‘conventional wisdom’ was not Lasker’s invention either. A Fairax editorial from a few months before the last election argued:

If one accepts the conventional wisdom on interest rates and elections, it’s a wonder the Reserve Bank board will bother at all with reviewing the official cash rate when it meets on Tuesday. Citing so-called convention, many people have all but ruled out a change in the rate until after the federal election.

One must assume that the editorialist wouldn’t have bothered writing this if the wisdom had no solid foundation at all.

In the quote from the Lateline story, Glenn Stevens seems to be referring to a remark that Ian Macfarlane made to Stephen Bell in an interview toward his book Australia’s Money Mandarins:

“It (the 2001 election) did have some small weight in our decision,” Macfarlane told Bell.

“If there was a really strong case to do something, we would always do it regardless of the election campaign. But it would have to be a pretty strong case.”

This, as far as I can gather, is the solitary hard datum supporting the alleged convention that rates will not be raised in an election year. But note that he says campaign rather than year. According to this story:

Macfarlane wrote to Bell after reviewing a transcript of the interview to ensure the word “campaign” was inserted after “election”, so that he was not misquoted. Even after the clarification, which narrowed the scope of his answer, the line defining where independence ends and politics begins has proved elusive.

Maybe, but there’s nothing elusive about the time frame. The Board lowered the cash rate in September, October and December 2001 — that is, in every month except November, the month of the election. Skipping November is on the one hand consistent with Macfarlane’s comment that the election had some small weight in what was otherwise a line-ball decision, and on the other hand completely inconsistent with a wider time frame.

So there was never any reason whatsoever to suppose that the Bank would leave the cash rate alone in an election year. And yet this week we still get this sort of thing in a national daily:

At a hearing in May, Mr Stevens had said “if in August it needs to be done, it will be done” – leaving some to say rates could be raised in election years but probably not during official election campaigns.

Is it possible that there existed at some point a taboo on adjustments during an election years, but one that applies only to interest rate rises, as Edwards and Lasker seemed to be saying? There is certainly no foundation for this in Macfarlane’s comment to Bell. He was talking about a year when the interest rate was being cut. In the absence of any explicit statements, the only evidence of a taboo against raising the cash rate in an election year/period/campaign would be an observed episode in which the rate was raised shortly after an election, suggesting it had been delayed during the interval in question. But this has never happened.

The 1993, 1996, 1998 and 2001 elections were all followed by cuts within a few months. Each of those elections came during an era of several successive cuts, so there is no reason to suspect that a rise may have been in the offing — but for the election campaign — on any of those occasions. The only candidate is 2004. There were no changes at all that year, but two towards the end of the previous year and then another one early the following year. It is possible that the notion of a taboo grew up around this single episode, but even this one instance is an extremely weak basis for a popular myth. It ‘s conceivable that the RBA was profoundly concerned about inflationary pressure throughout 2004 and that they held off until March 2005, five months after the election before raising the rate (just once) — and all this despite the fact that CPI inflation and the ‘underlying’ rate were right in the middle of the target zone during 2004.

Conceivable, and that’s all. But I’d be fascinated to know if all the streetwise and well-connected types out there really subscribed to this alleged conventional wisdom, or whether it was never more than a journalists’ invention.

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Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
14 years ago

Thanks for tracking down the quote. I was thinking of it in my post but didn’t go hunting for it. I think you make out a good case that the ‘convention’ has been worked up as a factoid by the media since Macfarlane’s comment. But I think the comment was ill judged. I don’t hugely mind the first half of it – though it’s a pretty slippery slope to say you accelerate and or delay possible changes in rate because of the way it might ‘play’ politically. It’s hard enough to get the moves right without adding that complication.

But judged against the inevitable fog of the monetary war against inflation, the second half of the quote clearly suggests a pretty heavy onus of proof against a move. I think that’s wrong. It’s nice to see Stevens knock it so comfortably on the head.

Jc
Jc
14 years ago

Steven”s comment has implications for lot’s of things. The central bank governor is one person we need to listen to. These people choose their words very carefully and the nuance is something that should never be missed.

Steven’s is basically saying that he will be adhering to the covenants of his job description that is to ensure we have sound money along with non-inflationary growth. I can’t recall the exact wording…..

This is something the workchoice roll backers ought to be listening to. Any whiff of wages tampering through some back handed legislative/union accord and this guy will be pushing down on the brake harder than an F1 car at the end of a straight.

I couldn’t imagine there is anyone who would disagree with him holding on to those priciples.

Jc
Jc
14 years ago

As an aside

For anyone wanting to know what the hell is going on in the financial markets but was too afraid to ask :-) there is a truly terrif scribe over at FT who does a fantasitc job at explaining the worlds credit markets.

every central banker in the world should be reading her columns first thing in the morings when they first appear.

Her name is Gillian Tett

Want to know what happened last week:

http://www.ft.com/cms/s/0/ea5fa08e-4d24-11dc-a51d-0000779fd2ac.html

I thought Rams was insured for all their obligations….. well there may be a long line at the insurers office if things get out of hand.

http://www.ft.com/cms/s/0/8479d180-4eb5-11dc-85e7-0000779fd2ac.html

Jc
Jc
14 years ago

Glenn Stevens not a hard money guy? Well he’s offering advice to the Bank of Japan too.

From blooomberg:
Among those cheering him on (BOJ Governor) is Reserve Bank of Australia Governor Glenn Stevens, who said in his semiannual testimony to his country’s parliament Aug. 17 that “the sooner the Japanese interest rates are able to be normal again, the better from the point of view of the global financial system.”

This flies in the face of IMF advice to the Japanese not to raise rates for fear of destabilizing the financial markets.

I think we may have caught a tiger by the tail with Stevens. I hope the pols understand what they have. Note the date on which the comment was made as were in the middle of the big storm.

Andrew Norton
Andrew Norton
14 years ago

Though as I understand it, the 1993 and 1996 elections should probably not be in sample, as the RBA was given greater independence to act after the 1996 election. Apart from Macfarlane’s comments about the 2001 election there had been such a tradition of political involvement in interest rate setting that there was probaby an expectation that bad news would not be announced in the lead up to an election.