Taylor’s daemon (and the Feb RBA minutes)

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As is often the case for the post SOMP minutes, the February RBA meeting minutes offer little that is new (see here for the SOMP review).

The RBA’s view, by now, is well understood: trading partner growth has turned up, both export volumes and prices are boosting national income, and financial conditions are easing by themselves. As a result, the RBA has time to wait and see if their weak(ish) forecasts command further easing.

By themselves, the forecasts do require further easing. However, with commodity prices flying it’s possible to see offsetting upside risks that augur against moving now. Given the outlook, it seems unlikely that the RBA will wait more than a few quarters.

For central banks must make policy according to their forecasts — even if these forecasts are highly uncertain — and the RBA’s current forecasts just are not good enough.

The monetary policy equivalent of Maxwell’s deamon — let’s call him Taylor’s deamon — would keep growth always around potential and inflation always around trend, by moving the cash rate pre-emptively according to his economic outlook / forecasts (which would always be correct!).

This way there would be no correlation between monetary policy, the unemployment rate, growth, or inflation. The latter three macro variable would be constant at whatever the central bank wanted them to be, and all the macro-economic volatility would be absorbed by the policy rate.

This is where i part ways with analysts such as the AFR’s Chris Joye. Chris argues that the fact growth was around trend last year and that core inflation is near 2.5% means that the RBA ought not to have eased so far.

The Taylor rule can be discovered as shocks are surprises, and the central bank responds to these unexpected innovations – but Taylor’s daemon would move his policy rate ahead of the shocks, to keep demand growth around potential, and inflation on target.


Optimal monetary policy is forward looking, and aims to keep growth around potential and inflation around 2.5%. It is hard to do, as forecasting is difficult, but the best thing to do is to try.

This is why i expect that the RBA will ease further (if they do not upgrade their growth and inflation projections). A forecast of sub-trend growth and sub-target inflation will not be accepted indefinitely. The RBA acknowledges this when they note that the outlook affords scope for further easing.

When might that occur?

Well with equities up further and the labour market looking stable (at slightly weak) it seems that the next move will be in Q2 or Q3. If commodity prices spike higher following CNY (as seems probable) we could well price out all further easing before this comes into focus – and let’s face it, if commodity prices remain elevated, we might have seen the last cut until the investment handover from mining is clearly in focus.


  1. Yep, without cuts, share market would still be in the low 4000 and AUD probably around 1.10

  2. I just struggle to understand why they think not cutting is the path of least regret. I think it would be a lot better to cut now and at worst raise in Q4 than to keep the drip therapy going for another 6-9 months. But at least this approach will provide a good test of CJ’s hypothesis that the RBA went 75-100 bp too far last year.

  3. boys and RA you are very slow on the uptake. CJ is one of the few journo’s to question the RBA’s party-line and put a different point of view. thank god for his fine intellectual and physical form

  4. Joye is a publicist who doesn’t think.he kept on harping about Real GDP which was above trend but ignored nominal GDP which was well below trend.

    This was not ignored here.
    The only way that inflation will rise is if nominal GDP rises. Hence Joye is predicting a commodity price boom ( across the board).
    If this occurs then the budget will become more contractionary. It is already structurally but it would be so cyclically as well.

    He may prove to be correct however at present it is difficult to envisage this as RA shows in his budget analysis.

  5. Why do I love to hate CJ? Perhaps his utter self-belief, relentless self-promotion and churlish inability to concede error is so utterly at odds with the typical INTJ personality type of most economists. Perhaps the thing I’ve found most irksome is him blaming the business influence on the RBA board when he gets his calls wrong, which to me smacks of taking your bat and ball and going home. As if the RBA board has never had members of a business and union background before… And as for the whole Martin Place nudie run fiasco, I for one was sorely disappointed when he backtracked out of it. I would have happily arranged a trip up the coast to enjoy the Sydney winter sunshine gleaning off CJ’s bare buttocks. Sure, maybe it wasn’t a Robertson-Keen type bet, but it was posted as a unilateral undertaking requiring no counterparty.

    Having said all that (as Larry David would say), I went back through his posts and my best guess is that he has supported only 2 cuts (Nov 2011 and May 2012). I don’t think he has supported any cuts since then, That would leave the cash rate at 4.25% from mid-last year. If the cash rate has really been 75 bp too high since June 2012 and 125 bp too high since December, we should start to see serious inflationary pressures and consecutive rate rises well before the end of this year.

    1. Chris is a mate of mine, and a good guy – in print, his voice is a little different than in person. I agree, he should have done the nudie run – i think it would have been good for his brand. Keen’s loss didn’t hurt him.

  6. CJ is by far the smartest economist in the land. and he never made the bet with Koukoulas. he offered but Kouk never agreed. it would be like holding economists including RA to account every time they changed their mind…

  7. I would also record CJ got Oct right, Nov right, Dec right, and Feb right. This blog only got Oct right because CJ and other called it, called a Nov cut, then initially said they would not move until Feb, getting Dec initially wrong, then changed its mind on Dec, and then called a Feb cut. it would seem that this blog’s combined intellect, including fans in the posts that laud it calls, has a vastly inferior intellect to the leviathan that is the great CJ……

  8. Getting forecasts is not the problem. It does happen to everyone. It is why people get it wrong.

    The Kouk was much more accurate than the publicity machine.
    He was continually saying the economy was too strong, commodity prices were rising et al when nominal GDP was well below trend.

    He is similar to Sinclair Davidson. He ignores his numerous mistakes and continues to pontificate as if nothing has happened.

  9. If he believes his own claptrap then he should be forecasting a budget in the black!
    He is certainly implying above trend nominal GDP growth afterall.

    Is he or doesn’t he undertand his own ‘logic’!

  10. My “Joye” moment.

    you have made it again!

    Actually I would be very surprised if everyone here didn’t enjoy most of the cited articles ( if you have the time!)

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