I’ve never understood central bank’s recent penchant for small changes in monetary policy – these days 0.25% per month. The idea is that the facts emerge slowly, economies respond to monetary policy slowly (with long and variable lags) so our changes should be slow too. But that doesn’t make any sense. These things can be said about the Titanic heading towards the iceberg. The Titanic was a large ship – 46,328 tons to be precise – it turned slowly, and the iceberg would have made itself out to the guys watching out for them slowly as they scanned the dark horizon. But once they decided to turn the rudder, they didn’t say “wait a bit, the Titanic only turns slowly so lets turn it in notches”.
The same basic principles apply to monetary policy. One is in a situation of considerable uncertainty, and in ‘normal’ times one might hope that adjustments to the monetary rudder might take place by the odd 0.25% movement. But in the last few months it’s become clear the expectations of inflation in the immediate future have ratcheted up by a percent or so.
Now one might take the view that it’s premature to raise rates, that the credit crunch is so serious that it will do a lot of the work for us. But that’s not the attitude the Bank took. And if that’s the case, it seems pretty likely that 25 basis points won’t do it. One can argue that real interest rates have fallen since the election. If you’re of that mind, it seems to me it would have made more sense to increase rates by more than 25 basis points last time – perhaps by 50 or 75 basis points.
I remember last time I argued this was when interest rates were at their height in early 1990. It seemed to me obvious that they should be reduced fairly quickly once it was clear they’d substantially slowed the economy. In fact reducing them was a long drawn out affair as this graph shows.
|30 Jul 1993||-0.50||4.75|
|23 Mar 1993||-0.50||5.25|
|8 Jul 1992||-0.75||5.75|
|6 May 1992||-1.00||6.50|
|8 Jan 1992||-1.00||7.50|
|6 Nov 1991||-1.00||8.50|
|3 Sep 1991||-1.00||9.50|
|16 May 1991||-1.00||10.50|
|4 Apr 1991||-0.50||11.50|
|18 Dec 1990||-1.00||12.00|
|15 Oct 1990||-1.00||13.00|
|2 Aug 1990||-1.00||14.00|
|4 Apr 1990||-1.00 to -1.50||15.00 to 15.50|
|15 Feb 1990||-0.50||16.50 to 17.00|
|23 Jan 1990||-0.50 to -1.00||17.00 to 17.50|
As you can see from the table, 100 basis point changes were the fashion back then.
I’m not holding myself out as knowing more than the RBA or anyone else about what the fundamentals of monetary policy should be here. I don’t envy them their task. But if I was thinking what I think the RBA is thinking, I don’t know why the last increase was just 0.25% – with talk of following it up with another one the next month. What would have been wrong with 0.5%?
Postscript: The Bank did consider a 50 basis point rise and decided against it, for reasons that look quite reasonable to me.