Gobbledigook

Every cycle of monetary policy seems to bring forward some piece of confused thinking that somehow turns up centre stage.  It’s not as if monetary policy is easy – given the inevitable level of ignorance and the long and variable lags in the effect of monetary policy. But central banks  have to make difficult decisions – like courts.  And then they have to justify them. And it’s tricky. And though I have the greatest respect for their predicament I recall asking when the RBA last reduced rates in a recession in the early 1990s, I asked why, once we were confident that we’d slowed the economy down, we didn’t lower rates faster.  I was told that it takes a long time for interest rates to work so we were lowering them gradually. (The obvious analogy is being on the Titanic and seeing the iceberg.  The rudder takes a while to have much effect, so we just move it

s    l    o    w    l    y

to its new position.)

The more recent version of this is ‘keeping your powder dry’ holding off on using your ammo.  With the greatest respect to Rory Robertson, here he is buying into this line explaining how the RBA’s policy of leaving rates where they are is justified if things turn up in the future.  And  . . .  also if they turn down.

If the RBA really had wanted to deliver a further substantial drop in key lending rates, it would have cut its cash rate more forcefully.  Bigger cash rate cuts may well turn out be necessary down the track, but for now the RBA is happy to sit and wait and watch, either hoping for better times ahead or saving its ammunition for darker days, or more accurately – both.  That is,the RBA is hoping for the best but remains prepared for the worst.  Like the rest of us!

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derrida derider
derrida derider
12 years ago

Yep, this “keep our powder dry” meme is due to an obvious logical fallacy, as I’ve said before. Even journos should be able to see that, let alone professional economists.

I sincerely hope that the RBA hasn’t fallen for it, and still believes we are only going to have a very mild recession. I’d prefer to think they have made a bad error of judgement than such a simple error of logic, though the risk (high real interest rates due to deflation) is the same in both cases.

pedro
pedro
12 years ago

Keeping the powder dry is illogical on its face, so maybe they mean to say they hope they have done enough and they will do more if it proves necessary. Reductions in interest rates penalise people relying on interest for their retirement and also create the risk of borrowing happening at unsustainable rates. The more you go down the more you have to come back, with the risk that the rebound will cause new problems.

Joshua Gans
Joshua Gans(@joshua-gans)
12 years ago

My feeling is that after several years of changing the interest rate by 0.25 percent at a time, the Board had convinced themselves that they could fine-tune, and were fine-tuning, the level of activity. Adjusting by several percentage points at once would have been an admission that they’d lost control.

Tel_
Tel_
12 years ago

The RBA have already cut rates to the point where banks show no interest whatsoever in passing the saving on to borrowers so what we are really discussing is whether the RBA should be boosting bank profit margins (and presumably boosting bank share prices along with that).

The more recent version of this is keeping your powder dry holding off on using your ammo.

It’s a bluff, they have done what they can, there is no more powder to keep dry.

ennui
ennui
12 years ago

Nick

Just a minor point re your “obvious” (but poor) analogy –
“The rudder takes a while to have much effect, so we just move it slowly to its new position”

Any sailor would tell you that a rapid movement of the rudder in boisterous seas could cause the water flow to detach from the rudder thereby leading to loss of control of the yacht eg a broach! In other words, a rapid correction could produce disasterous consequences. To lose control because of “iceberg” panic does not appeal as good management!!

I might add, this pedantry does not detract from the validity of your argument – it simply points to the dangers inherent in analogies!!