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Economists ponder the RBA under Lowe

AAP logoAAP 30/09/2016 Garry Shilson-Josling, Economist

With a Reserve Bank board meeting looming, economists this week looked ahead to the likely decision on interest rates and how the central bank's approach might shift under its new governor.

On Friday afternoon, the futures market gave the likelihood of a cut in the cash rate on Tuesday - from its current record low of 1.5 per cent - a token one in 50 chance, in line with the strong consensus among economists.

But there's more to the decision than just the rate itself.

Economists will pick over Philip Lowe's first statement since he took over as governor from Glenn Stevens.

Commonwealth Bank economist Gareth Aird says this means there's a good chance the announcement will be "fresh", rather than just a minor tweaking of the previous one.

"The post-meeting statement belongs to the Governor after all," he said.

Subtle changes to the policy framework agreed with the government since Dr Lowe took the helm suggest the hurdle for another rate cut has been lifted a touch, Mr Aird said in a report.

One is the change in wording to say the RBA will target inflation of two to three per cent "over time" rather than "on average over the cycle".

This could be no more than a tacit acknowledgement that there is no regular, predictable business cycle, as opposed to the unpredictable ebb and flow of an inherently unstable economy.

But, like Mr Aird, most economists appear to view the wording change as an indication that the RBA intends to be more relaxed about the time taken to bring inflation back on target when it strays - as it's doing now - on the low side.

The other change is the subtle shift in tone that gives more weight to financial stability, Mr Aird said.

That implies the risk of stoking the housing market bolsters the arguments against more rate cuts.

And if the RBA is focusing more on financial stability, Westpac's veteran chief economist Bill Evans says the roots of this approach can be found in Dr Lowe's "defining moment" as an economist.

That moment came when the young Philip Lowe co-authored a working paper in 2002 while on secondment from the RBA to the Bank of International Settlements in Basel, Mr Evans said.

The standard approach at the time was for central banks to focus on keeping consumer price inflation steady, while letting markets have their head, then use low interest rates to clean up any mess after they crashed.

It was the approach favoured by Alan Greenspan, chairman of the US Federal Reserve from August 1987 to January 2006.

"Young Lowe clearly disagreed ... That paper, all those years ago, gives us a clear insight into the values of the new governor" Mr Evans said.

"Arguably, if his warnings had been heeded by Chairman Greenspan back in 2002 (note that he only started rising rates in June 2004), the world may have avoided the Global Financial Crisis."

Mr Evans said those values evident in Dr Lowe's 2002 paper will be an important driver of future policy.

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