A natural experiment
Last week witnessed two fascinating developments in the monetary realm. First, the Reserve Bank of Australia (RBA) put a halt to its tightening cycle, citing the long and variable lags of monetary policy and the need to assess the impact of the interest rate hike on the economy:
“The Board recognises that monetary policy operates with a lag and that the full effect of this substantial increase in interest rates is yet to be felt. The Board took the decision to hold interest rates steady this month to provide additional time to assess the impact of the increase in interest rates to date and the economic outlook.
The Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target. The decision to hold interest rates steady this month provides the Board with more time to assess the state of the economy and the outlook, in an environment of considerable uncertainty.”
In contrast, the Reserve Bank of New Zealand (RBNZ) raised rates by double what traders were anticipating, with the goal of returning inflation to the 1-3% target range over the medium term. The RBNZ began hiking rates six months before the RBA and its cash rate is now 5.25%, a full 165 basis points above Australia’s:
“The Committee agreed the OCR needs to increase, as previously indicated, to return inflation to the 1-3 percent target range over the medium term. Inflation is still too high and persistent, and employment is beyond its maximum sustainable level.
The Committee agreed that the OCR needs to be at a level that will reduce inflation and inflation expectations to within the target range over the medium term. The Committee agreed that maintaining the current level of lending rates for households and businesses is necessary to achieve this, along with a rise in deposit rates. New Zealand’s financial system is well positioned to manage through a period of slower economic activity.”
What we have here is a little natural experiment: both countries cut rates to zero and implemented unprecedented stimulus during the pandemic, and both are now experiencing record-low unemployment, similar rates of inflation well above target, and nominal GDP growth of over 10% per annum. Will Australia get lucky, or will the more prudent Kiwis come out of this one looking the goods? Noting of course that there are countless factors beyond the control of either central bank that could derail the experiment before we can get an answer.