Responsive policy means rising rates
Central banks in future are likely to adopt a more "responsive" approach to monetary policy that attempts to detect the build of financial instability (or asset bubbles) and to act in sufficient time for a tighter monetary policy to make an impact, a trio of Reserve Bank of Australia officers, including the governor Glenn Stevens, argued in a paper published yesterday.
The RBA officers presented the paper at a symposium to mark the 50th anniversary of the RBA in Sydney yesterday, with the paper published at the RBA website.
In their paper Stevens and colleagues revisit the long-running debate over the place for conventional monetary policy in tackling asset bubbles.
They argued that "it is unlikely that we will ever overcome the problems of uncertainty to a degree that warrants aggressive 'popping' of asset-price bubbles.
"But, to repeat, couching the debate in those terms is potentially misleading and quite unhelpful.
"The problem is not one of asset prices per se: it is one of risks and imbalances building in the financial system, as often indicated by a combination of rapidly rising asset prices and credit, and falling lending standards.
"In any event there is a large distance on the spectrum between passively accepting asset and credit developments and aggressively seeking to reverse them.
"Even with the development of other tools, it is unlikely to be credible for central banks not to move, in the next decade, at least somewhat in the 'responsive' direction."
Stevens then moved on to place this issue in the context of considerations of fiscal policy.
"Will governments," he asked, "be able to match their expansionary fiscal activism with a corresponding degree of discipline to restore budgets to sustainability?"
While he was not talking about the situation in Australia directly, many will assume that he was, one reason being that he offered up a medium-term policy trade off.
"If governments do respond to the debt trends by fiscal consolidation at some point, this may well inhibit growth for a time. How should monetary policy be conducted in that period?" Stevens asked.
"The straightforward answer is presumably that it would remain more accommodative than otherwise.
"There may well be attractions for fiscal authorities in committing to a path of relatively rapid fiscal consolidation, thereby allowing monetary policy to be more
accommodative than otherwise.
"This would have the advantage of keeping down the costs of servicing public debt in the meantime. It would also reduce the potential for the 'crowding out' of private investment normally associated with high fiscal deficits and upward pressure on interest rates, particularly once central bank purchases of government debt cease, as eventually they must."