Reserve Bank Of Australia Research Articles

Evaluating Australia's financial conditions: A comparative analysis and extension of a dynamic factor model index

AbstractThis article investigates the unique financial conditions in Australia in the wake of COVID‐19, a subject of critical importance given the recent unprecedented economic events such as the fastest rate rises since the 1990s and the presence of persistently high inflation. This study aims to contribute to the literature by examining the speed of interest rate changes and its implications on financial conditions, particularly in an environment characterised by negative real interest rates. The research aims to extend and refine the financial conditions index (FCI) developed by the Reserve Bank of Australia by incorporating a momentum variable to capture the speed of interest rate changes. A dynamic factor model is utilised to investigate 73 data series across nine main categories, constructing the FCI on a quarterly basis. The results indicate that rapid interest rate changes significantly impact financial conditions, holding significant weights within the model, thus requiring careful policy considerations.

Do central banks respond to house price movements? A Bayesian DSGE approach

AbstractThis thesis explores whether monetary policy reacts to house price movements, by employing a New Keynesian model with a housing factor and estimated using Bayesian estimation techniques. The primary emphasis of this study is on the United States, with supplementary analyses on central banks in several advanced economies. The principal finding of this thesis reveals that the Federal Reserve responded substantially but episodically to house prices. Furthermore, my investigation indicates that the Reserve Bank of Australia, the Reserve Bank of New Zealand, Bank of England, and the European Central Bank did not incorporate house prices into their policy framework, whereas the Bank of Canada did so episodically. The baseline results remain robust across a range of sensitivity checks.

The Role of Housing Costs in Central Banks’ Inflation Targeting Regimes: The Cases of the Reserve Bank of Australia and the Bank of England

Since the 1990s it has become common for central banks to be charged with using interest rates to meet consumer price inflation (CPI) targets. This article examines the cases of the Reserve Bank of Australia (RBA) and the Bank of England (BoE) and finds that whereas the RBA’s CPI target includes a housing cost element, the BoE’s does not. Moreover, it finds that contrasting treatments of housing costs produce different results, depending on whether the index includes mortgage interest as a housing cost. Whilst central banks dislike CPIs that include an element of mortgage interest because of the apparently perverse outcome of increasing interest rates, they also lack credibility by excluding such an important element of the cost of living. Credibility demands that the 30-year consensus on inflation targeting by monetary policy be replaced by a broader set of tools – including fiscal policy – to control inflation.

Classification of RBA monetary policy announcements using ChatGPT

ChatGPT is a tool that has gained much attention and has accelerated the adoption of Artificial Intelligence across many applications. Using monetary policy decisions made by the Reserve Bank of Australia (RBA), we test whether ChatGPT's classifications of monetary policy announcements are consistent with market-observed characteristics, whether this has changed with the update from GPT-3.5 to GPT-4, and whether this provides additional informativeness for changes in the yield implied by interest rate futures. Our results indicate that, regardless of statement readability, ChatGPT provides a classification of hawkish / dovish tone that is consistent with “Target Surprises” and “Path Surprises” and although it seems to improve in the latest version has more difficulty with “sentiment” classification. However, this information does not appear to help to explain changes in interest rate markets on the day of the policy announcement.

Monetary Policy Mistakes and Remedies: An Assessment Following the RBA Review

AbstractThis article responds to the Review of the Reserve Bank of Australia (RBA), which was released on 20 April 2023. We describe the underperformance of the Australian economy over the past decade, and identify the contribution of RBA mistakes. We suggest remedies that would improve prospects for low inflation and unemployment. Returning to general prosperity requires better coordination of monetary, fiscal and macro‐prudential policy and of these with other aspects of economic policy‐making. We conclude that while the RBA Review makes some valuable suggestions about structure and process at the RBA, it provides little guidance on the content of policy.

The RBA (Reserve Bank of Australia) Review 2023: A missed opportunity

AbstractThe 2022–2023 review of the Reserve Bank of Australia, published in March 2023, was a missed opportunity to reconsider the currently dominant framework for monetary policy. This framework, based on strong central bank independence and reliance on adjustments to central bank interest rates to achieve a 2–3% inflation target, has performed poorly at a global level and is no longer sustainable. A new framework, accepting a higher average rate of inflation and taking explicit account of the objectives of full employment and economic prosperity, is needed.

Housing Fever in Australia 2020–23: Insights from an Econometric Thermometer

AbstractAustralian housing markets experienced widespread and, in some cases, extraordinary growth in prices between 2020 and 2023. Using recently developed methodology that accounts for fundamental economic drivers, we assess the existence and degree of speculative behaviour, as well as the timing of exuberance and downturns in these markets. Our findings indicate that speculative behaviour was indeed present in six of the eight capital cities at some time over the period studied. The sequence of events in this nation‐wide housing bubble began in the Brisbane market and concluded in Melbourne, Canberra, and Hobart following the interest rate rise implemented by the Reserve Bank of Australia in May 2022. As of March 2023, the housing markets in Sydney, Canberra and Hobart had broadly regained stability, while Melbourne's return to its normal state is more gradual. In addition, over‐corrections against fundamentals are evident in the housing markets of Brisbane, Adelaide, Darwin and Perth. For regular updates on the housing markets, readers may visit the authors' website at https://www.housing-fever.com.

Developments in Australian Bank’s Funding Costs and Lending Rates

This paper focuses on the funding costs and the lending rates of banks in Australia. As the world emerges from the COVID-19 pandemic, more and more countries need to change their financial policies to fit the new situation. In this trend, the central bank of Australia, which is the Reserve Bank of Australia, plans to increase its cash rate to stop or reduce the starting rate of inflation. Through analyzing the report from the Reserve Bank of Australia (RBA) and articles from related academic works of literature, this writer found some points to understand, evidence, and analyze. It also analyze the importance of the Australian central bank to change the cash rate. After analysis, the result shows that due to the change in the confidence of customers and the increase of the rate of inflation after the COVID-19 pandemic, the central bank had to increase the cash rate. Through tighter financial policies, the central bank planned to stabilize the economy of Australia. Meanwhile, the pressure of Australian banks grew as the funding cost increased and the requirement for home mortgage loans decreased. For future research on the cash rate, it is advised to evaluate that if the continuous increases in cash rate are overused in the future. This might need at least half a year or even longer time to wait for the impact of the policy and the effect on the market and the banks.

Forward guidance and expectation formation: A narrative approach

SummaryHow forward guidance influences expectations is not fully understood. To study this, I construct central bank data that includes forward guidance and its attributes, central bank projections, and quantitative easing, which I combine with survey data. I describe how, when, and where forward guidance has worked. I estimate that forecasters revised their interest rate forecasts in the intended direction by five basis points on average following a forward guidance change. I provide estimates for The Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Reserve Bank of Australia, Reserve Bank of New Zealand, Sveriges Riksbank, and Norges Bank.

The Nationalisation of the South African Reserve Bank: a Legal-Historical Perspective of Three Central Banks

The debate continues about whether the South African Reserve Bank should be nationalised or not. This contribution looks at the evolution of central banks, as well as at the origin and historical background of the central banks in three countries, namely the South African Reserve Bank, the Reserve Bank of Australia and De Nederlandsche Bank. The shares in the South African Reserve Bank belong to private shareholders; the Reserve Bank of Australia has been the property of the government of Australia since its inception; and De Nederlandsche Bank was nationalised in 1948. The potential nationalisation of the South African Reserve Bank will come with a hefty price tag, as the shareholders will have to be compensated for the value of their shares. Section 224 of the Constitution of the Republic of South Africa, 1996 determines that the South African Reserve Bank should “protect the value of the currency in the interest of balanced and sustainable economic growth”. The constitutional power of the Bank to be responsible for monetary policy will not change if it is nationalised. This contribution recommends that the South African Reserve Bank not be nationalised due to the big cost thereof to South Africa and because not much will be achieved by such a step.

The Role of Property Prices in the Conduct of Monetary Policy: Evidence from Down Under

This paper examines link between property prices and monetary policy in New Zealand and Australia. Using an identified VAR model for open economies, we address two questions, i.e., whether a loose monetary policy cause house price appreciation, and whether central banks of the two countries conduct a policy of “leaning against the wind” by responding to house price shocks. Our findings suggest that, following an expansionary monetary policy shock, house prices inflations fall immediately. Yet, we find that the impact of monetary policy shocks on housing is small to modest in both countries. Furthermore, we find that the interest rate does not respond systematically to changes in house prices in New Zealand, whereas the Reserve Bank of Australia do respond systematically to fluctuations in housing price inflation.

How well placed are households for interest rate increases

As in many other countries, inflation in Australia has risen quickly over the past 18 months and is now higher than it has been since the early 1990s. In response, the Reserve Bank of Australia (RBA) Board has been withdrawing the extraordinary monetary policy stimulus that was put in place during 2020 to support the Australian economy through the economic effects of the pandemic. One of the areas the RBA will be closely observing as it tightens policy is how households respond to the combination of rising interest rates and prices. This article deals with the implications of rising interest rates for the household sector with a focus on the implications for financial stability. In doing so, the article will chiefly focus on indebted homeowners since such households pose a greater direct risk to the financial sector than those groups for whom there are also implications such as renters and those who own homes outright. Therefore, an understanding of the impacts of higher interest rates on indebted households is directly relevant to gauging how the economy and the financial sector might be affected.

Assessing Australian Monetary Policy in the Twenty‐First Century*

Using the Reserve Bank of Australia's MARTIN model, we compare actual monetary policy decisions with a counterfactual in which the cash rate is set according to an optimal simple rule. We find that monetary policy played a crucial role in avoiding a potential recession in 2001 and mitigating the downturn in 2008–09. By contrast we find that the cash rate was too high during 2016–19, keeping inflation below the Reserve Bank's target band. Optimal monetary policy in 2016–19 would have involved a substantially lower cash rate and produced significantly better employment outcomes.

Estimating an optimal macroeconomic uncertainty index for Australia

ABSTRACT In this article, an optimal macroeconomic uncertainty index is constructed for the Australian economy. This index is derived from a small structural macroeconomic model. The structural model is first estimated using GMM to extract the parameter estimates, which are then used to initialize maximum likelihood techniques in order to obtain the optimal coefficient values for the relevant variables. The relevant variables are then weighted by the obtained optimal coefficients and, finally, are aggregated to produce the optimal macroeconomic uncertainty index for Australian economy. The empirical results show that the uncertainty index constructed is a good indicator of the optimal economic conditions in Australia, providing a useful tool to assist the Reserve Bank of Australia in its decision-making process.

Inflation Expectations in Australia

AbstractInflation expectations are typically considered a pivotal and causal driver of inflation dynamics over which central banks have a strong influence. Given this influence, it is important for central banks to understand how expectations are formed and how their operations influence these expectations. We describe the various ways inflation expectations are measured and used by the Reserve Bank of Australia (RBA), and then review the evidence on how Australians form their expectations. In contrast to what is assumed in standard macroeconomic models, expectations are generally not formed rationally or with full information. We close by highlighting what these findings imply for the conduct of monetary policy.

Monetary policy in a world of radical uncertainty

Monetary policy in a world of radical uncertainty

The Reserve Bank of Australia’s pandemic response and the New Keynesian trap

The Reserve Bank of Australia’s pandemic response and the New Keynesian trap

Does foreign monetary policy drive Australian banks' wholesale funding costs?

In this paper, we analyze whether Australian banks' wholesale funding (WF) costs are driven by foreign monetary policy. Using data for 2000–2015, we find that in aggregate, WF costs are not directly affected by the Reserve Bank of Australia's cash rate, except for issues in Australian dollars. The impact is indirect, through the yield of Australian government bonds. WF costs for issues in non-Australian currencies (except Japanese yen) depend on foreign monetary policy. The paper also shows that WF costs do not depend on the volatility index and exchange rates. Our results have implications for regulators and monetary-policy makers.

Modelling the Reserve Bank of Australia's Policy Decisions and the Case for a Negative Cash Rate

AbstractTaylor's eponymous ‘rule’ models how central banks set policy rates in response to inflation and output. We estimate a Taylor rule for the Reserve Bank of Australia (RBA), modifying it to make it more realistic, while retaining its simplicity. The model implies that if the Bank responds to recent forecasts as it has on average since 1995, the cash rate could have briefly gone negative in 2020. But the RBA is wary of negative cash rates. There are grounds for caution; the economic outlook is particularly uncertain and the economy's response to negative rates is uncharted territory.

Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track

This paper makes the case for the adoption of nominal income targeting in the context of an improved governance and accountability framework for the Reserve Bank of Australia (RBA). The paper begins by outlining the existing governance and inflation targeting framework for Australian monetary policy. The RBA has increasingly underperformed its inflation and full employment mandates under this framework because of a combination of policy errors and policy choices. This left the Australian economy with a weak starting point going into the COVID-19 pandemic. The RBA’s initial response to the pandemic was limited due to its reluctance to embrace large-scale asset purchases (LSAP). A nominal income target, supported by governance and accountability reforms, would improve monetary policy decision-making by alleviating the knowledge problems faced by policymakers. The paper also shows how public policy could support a nominal GDP (NGDP) futures market to better inform monetary policy decisions.