Forecasting key to monetary policy decisions

Release date
15 March 2013

Making sense of what is going on in the economy and forecasting future economic conditions are essential for making good monetary policy decisions, the Reserve Bank's Assistant Governor John McDermott said today.

In a speech to the Financial Services Institute of Australasia, Dr McDermott said forecasting can be difficult, because the economy is never static and monetary policy actions take time to influence inflation. But forecasting is an important element of the Bank's communication of policy and risks.

Dr McDermott said there is no single "correct" way to look at the economy, and the Bank draws on a range of official data, statistical models, surveys, business visits and market monitoring to shape its view of the economy.

"The forecasting framework includes some fundamental economic principles to anchor our analysis and dialogue. These include the big lesson from the 1970s experience, that you can't sustainably get higher growth by tolerating a bit more inflation, and that to try to do so will eventually cause high and variable inflation, and damage the economy."

Currently, monetary policy faces some big forecasting challenges, including the treatment of the persistently high exchange rate, high household debt and accounting for the substantial Canterbury rebuild. The Bank must predict the balance of the opposing economic forces, recognise the uncertainties and account for trade-offs.

"For example, it may seem there is room to cut interest rates, given we are below our inflation target. But we have had to weigh up that such a cut would also probably exacerbate the current strength in house prices, resulting in higher debt levels and potentially raising financial stability issues."

Dr McDermott said the Bank goes to extensive efforts to ensure the economic outlook and the strategy framing monetary policy decisions are as clear as possible, as this helps policy makers, firms and households to plan for and adapt to changing circumstances.

"The Monetary Policy Statement acts as a record of our monetary policy deliberations. Some other central banks instead publish minutes of their monetary policy meetings, which amounts to much the same thing."

Dr McDermott said the Bank needs to anticipate and consider a range of economic outcomes. "This enables us to keep the OCR as well-positioned as we can, and our policy strategy well-understood, so that our efforts to maintain stable inflation do not cause more economic volatility than necessary."

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