A Tale of Two Central Banks

October 7, 2008

I had hoped that the Reserve Bank of Australia would exceed market expectations with the size of its rate cut, and officials there delivered with their largest since reduction since 1992, a 100 basis-point cut to 6.0%. Today’s move follows a 25-bp cut in September, which had been the first easing since 2001.   The aggressiveness of the latest move did not stem from domestic economic conditions, which a released statement said were moderating as desired and in line with what the Board was expecting.  RBA officials acted because of what they observe around the world: “large-scale financial failures,” seriously impeded interbank markets, sharply lower share prices, and instability in other markets.  Officials noted that Australia’s local balancing system is relatively strong, but they expect difficult financing conditions around the world to persist “for some time ahead” and perceive as a result a “risk that demand and output could be significantly weaker than earlier expected,” which in turn would cut inflation “faster than earlier forecast.”  Even though inflation in 3Q is projected at a 12-month rate of 5%, two percentage points more than the acceptable ceiling, policymakers saw “a material change to the balance of risks surrounding the outlook” and concluded such “requires a significantly less restrictive stance of monetary policy.”  While warning that today’s deep cut does not necessarily establish “a pattern for future decisions,” the statement did not explicitly close the dollar on further easing.  With the call rate still lofty at 6.0%, Australia’s terms of trade likely to fall in the coming year, and confidence in global money markets completely shot, investors will be under little illusion that more reductions in the cash rate lie ahead and are likely to be implemented with reasonable dispatch.

The Bank of Japan also held a Policy Board meeting, which fell into old habits of denial and hope.  After deliberating for six hours and forty-seven minutes over two days, policymakers voted unanimously yet again to leave its uncollateralized overnight call rate at 0.5%.  When judging monetary policy, it is important to look at levels as well as changes in that level.  0.5% is lower than rates everywhere else, but such has not fallen since February 2007, that is from before the start of the global credit crunch and the subsequent onset of recession in Japan.  The statement concedes that growth is “sluggish,” the term used by the central bank in the past to connote recession, but adheres to the continuing view that “in the longer run, the economy is expected to return gradually onto a moderate growth path.” The statement identifies intensifying downside global financial market strains and risks to world growth, plus weakening income growth in Japan that “could potentially weigh on domestic private demand.”  A sharper warning against upside price risks than downside price risks is maintained, even though Japan has only emerged recently from a prolonged bout of deflation and despite a severe financial market-driven global slowdown, the very kind of event that historically has been associated with falling prices.

Australia’s big rate cut has fueled hopes that the Fed and European central banks will also soon ease their monetary policies, starting with the Bank of England this Thursday.  The unanimity of the Bank of Japan vote and the similarity of its latest position to what has been said all summer despite a spiraling deterioration in global markets suggests that Japanese monetary officials are not prepared to revert to drastic forms of stimulus like quantitative easing even if the situation warrants.

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