De-mystifying RBA Setting of Interest Rates

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My previous blog post on the RBA noted their tendency to follow a Taylor Rule prior to the GFC. A colleague points out another statistical regularity that holds either side of the GFC, and right back to 1990: the RBA’s decisions follow the 90-day bank bill. Below are Phil Williams’ observations on this issue.

In the days running up to the first Tuesday of each month, the Australian populace is subjected to the excruciating pageantry of whether the RBA Board will increase or decrease interest rates, or whether they will keep them on hold for another month.

Economists take a break from their routine of poring over mountains of statistics and econometric models to come forth and give their solemn prognostications to an adoring public. Financial commentators spring to life like wildlife awakening from the first rains of the wet season, waiting with bated breath on what those extraordinary men and women of the RBA Board might decide.

And then the press statement is released, trading floors spring to life and newspapers splash forth on what it may mean to the lives of the heavily indebted peasantry. This monthly charade also gives politicians an opportunity to spruik their wares. And then we wait for the process to start again next month.

As a humanitarian, I would like to save us from this dreadful spectacle and give each of us the opportunity to track what the RBA might, or might not do in real time. In so doing I hope to de-mystify the process, by stating that the RBA doesn’t lead the way in setting rates, the market does. The RBA is a follower, not a leader.

The following graph plots the 90-day bank-accepted bill rate (red line) and the RBA target cash rate (black line) from January 1990 to 28 July 2011. The blue line at the bottom shows the percentage difference between the two rates. The data is sourced from the RBA’s own web-site, Table F1, “Daily Interest Rates and Yields – Money Market”.

The graph shows an almost 100% correlation between the cash rate and the 90-day bank bill rates. However the data also shows that in almost every instance the RBA cash rate FOLLOWS the 90-day bank bill rate, rather than leads it. The data also shows that the RBA will generally increase rates once the 90-day bank bill rate gets 50 basis points or more above the RBA cash rate. The actions on the downside are not as tight, with decreases in cash rates occurring when the bank bill rate is anywhere from 0 to 100 basis points below the 90-day bank bill rate. However as a rule of thumb the RBA tends to decrease the cash rate when the 90-day bank bill rate is 50+ basis points lower than the cash rate.

This analysis raises a number of interesting questions:

  1. Why do we have the RBA as an interest-rate setting body at all when all they do is follow the market?
  2. Why does the RBA shroud itself in such mysticism when their actions are so transparent to all?
  3. What is the quality of our economists, politicians and financial commentators that we have to go through the “Will They or Won’t They” pantomime each month?
  4. How could any economist get their forecasts wrong, particularly on the up-side?

I can only say one thing in defence of the RBA. They are not as destructive as the Bank of England, the ECB or the activist US Federal Reserve.

Phil Williams

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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31 Responses to De-mystifying RBA Setting of Interest Rates

  1. mahaish says:

    think youve grabbed the wrong end of the stick lyonwiss,

    have you heard of a system wide surplus in the interbank lending market,

    a deficit creates excess reserves, are we agreed on that point.

    excess reserves creates competition between banks when lending to other banks , since its better to earn a market rate than a lower rba mandated support rate

    remember banks cant effect the liquidity position of the overall market

    so depending on the liquidity position of the whole banking system, it can force the overnight funds rate downwards

    when there is a system wide surplus,

    the central bank can intervene in the market and conduct open market ops to reach desired rate target,

    but absent such intervention, and in the case of australia absent a support rate,

    excess liquidity in the interbank lending ,market can force rate down to zero

    short term bonds are a proxy for short term interest rates, so their yield will reflect movements in the overnight rate

  2. Lyonwiss says:

    Mahaish August 7, 2011 at 8:56 pm

    You said: “a deficit creates excess reserves, are we agreed on that point.” No, totally disagree. Please look at the data on reserves, debt, interest rates etc. to avoid talking nonsense. Many governments are losing financial control right now due to over-indebtedness.

  3. LCTesla says:

    @ Adam: a good person to watch might be A. Gary Shilling, a person predicting macroeconomic trends similarly to Keen (i.e. deleveraging rules the roost) who focuses on investment opportunities. I believe he recommends US Treasuries, which he notoriously estimates to appreciate in value (i.e. falling interest rate) despite already being historically low yielding. So far, his advice seems to pan out well (10 year yields @ 2.5%; though let’s wait how the S&P downgrade gets priced in on monday before granting victory). For a glimpse of how far down yields can go, look at Japan: 1% 10 year yield at 200% public debt/GDP!
    ps. I can not say whether Keen endorses Shilling’s advice.

  4. footsore says:

    Hi Adam,
    I think that I’m in the same position as you in regards to increasing my knowledge of economics and the desire to make some (any!) sense out of it. I recently read a book that I found to be very helpful. It doesn’t seek to answer any particular question but it does give a good overview of the notions of markets and the role of governments. I also thought that it was quite even handed in that it attempted to point out both the good and bad features of the systems and ideas that it looked at. The book is called ‘Naked Economics: Undressing the dismal science’ and it is by Charles Wheelan. Best of luck with your endeavour.

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