The Reserve Bank has adjusted the way it communicates forward guidance for monetary policy and narrowed most of that guidance to cover months rather than several years after an internal review found shortcomings in the way official rate policy was transmitted to the Australian public during the pandemic.
The findings of an intensely reflexive review of the central bank’s guidance was published on Tuesday by the RBA board.
It was prompted by the savage public backlash against the decision in May this year to start raising official rates even though the RBA’s forward guidance given in July 2021 indicated that monetary tightening was not likely before 2024.
Changes to the way the RBA communicates forward guidance have been judged by the board to be necessary after the review found that “communication regarding the conditionality of the forward guidance could have been clearer”.
“During the pandemic, the Board stated that it would not increase the cash rate until certain economic conditions had been met,” the internal review observed.
“But these conditions were not sufficiently clear and were not well understood.
“At times, the communication was overly complex.
“The time aspect of the Board’s communication came to dominate the messaging, with many people focusing on the time aspect rather than the economic conditions.”
The review highlighted that the unique circumstances created by the pandemic resulted in the RBA changing the format of its monthly guidance statements to include more information about the implications of economic forecasts and conditional medium-term commentary about when rates might start rising again.
For most of 2020 and 2021, the RBA board was signalling that the first official rate rise was not expected for at least three years and then adjusted that to not until “2024 or later”.
While the review found that such guidance was always conditional, the board lost control of its public messaging earlier this year because Australian borrowers had interpreted the forward guidance issued throughout 2020 and 2021 as a promise.
“The fact that many people interpreted the forward guidance as ‘a promise’ that there would be no rate raises until 2024 led to considerable reputational damage to the Bank,” the review found.
“When the cash rate was increased in May 2022, many people saw the Bank as having broken ‘its promise’.
“In hindsight, and focusing only on forward guidance, a less specific timeframe, or one covering a shorter horizon, would have been preferable.
“Given the outlook was highly uncertain, the Board could have given more consideration to potential upside scenarios, including scenarios that could warrant the Board raising the cash rate earlier than anticipated.”
The review found that the complicated public messaging was exacerbated by the board’s attempt to explain what it meant for inflation to be sustainably within the target range of between 2 per cent to 3 per cent.
The board focused much of its commentary on inflation around the outlook for wages.
“This further complicated the messaging, with many commentators interpreting the Board as having a wages target,” the review found.
“A specific number for wages growth (3 per cent) served as an anchor point and there was some confusion among commentators over what wages data were being considered.
“In the end, there was some perception that the Board moved later than it should have as it waited for evidence on wages growth before raising rates.”
The review found the board’s commentary would have been less exposed to misinterpretation had it been focused specifically on inflation conditions, rather than wages as a driver of inflation.
While the review observed that there were some benefits for the central bank to issue guidance about the likely path of official rate policy, it is also heightened risks.
“Given the inherent uncertainty about the economic outlook, there are risks to communicating complicated messages, imposing a high level of conditionality and providing guidance on the likely path of policy rates over a long horizon,” the review observed.
“Taking on the lessons of recent experience, the Board now favours a less specific approach than that used during the pandemic.”
Critics of the RBA’s handling of monetary policy during the pandemic, such as senior economist Stephen Koukoulas, yesterday welcomed the findings of the review.
“There have been some errors of judgement, we all know that,” Koukoulas said.
“However, we should acknowledge that the RBA didn’t provide that guidance to be mischievous, it was forward guidance that they were confident about the time.
“I think it’s encouraging that they’re now acknowledging some silly things were done and that some aspects of the forward guidance they issued in recent years were hazardous.”
Since the board meeting in May the RBA has reined in the detail included in its monthly outlook statements and reverted to limiting commentary on future rate movements to periods covering months, rather than years.
“This involves providing some guidance about future interest rates where it is appropriate to do so, and over a fairly short period,” the review observed.
“The focus will continue to be on explaining the decision-making framework.
“It is unlikely that the Bank will draw out in detail the implications of that framework for the timing of future interest rate changes, although it does not rule out doing so.”