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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  • mahaish

    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

  • Lyon­wiss

    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.

  • LCTesla

    @ 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.

  • foot­sore

    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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