Ideas@TheCentre
Monetary policy can’t buy economic growth
Monetary policy has recently come in for criticism from a number of quarters. Paul Howes of the Australian Workers’ Union said, ‘the Reserve Bank has made the wrong call consistently’ and called for its charter to be changed.
The only relevant test for monetary policy is inflation outcomes. The ‘core’ measures of inflation that best predict future inflation have been consistent with the 2–3% inflation target since the September quarter 2010. This tells us that monetary policy has been broadly correct in recent years. It is no coincidence that the Reserve Bank of Australia (RBA) last raised the official cash rate in November 2010. This tightening in monetary policy no doubt moderated economic activity subsequently, but that is how monetary policy is supposed to work.
Some have called for monetary policy to be used to lower the exchange rate. Far from being a problem, a high dollar helps contain inflation and is just one of the channels through which monetary policy works to moderate economic activity. The RBA’s official interest rate already takes account of the effects of the exchange rate on the economy. The point of floating the dollar in 1983 was to have an exchange rate that reflected the needs of the economy and not the whims of politicians, farmers and union leaders.
The assumption that we can buy additional economic growth through monetary policy and manipulating the exchange rate is mistaken. In the long run, money is neutral with respect to the real economy. However, a well-run monetary policy should also have few real effects even in the short run.
US economist John Taylor has shown that official interest rates are largely explained by the current and past state of the economy. The remainder that cannot be explained measures the discretionary component of monetary policy and is usually very small.
In other words, it is usually the economy that drives monetary policy, not the other way around. This is how it should be. It’s only when the real economy starts dancing to the tune of monetary policy that the real trouble begins.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies and a Senior Lecturer in Economics at the University of Technology Sydney Business School.
