RBA should move to 10 basis-point cuts

With yesterday's drop in the official cash rate to a record low of 2 per cent, two La Trobe University economists have suggested the Reserve Bank should consider reducing the increment of subsequent reductions from 25 to 10 basis points.

Drs Liam Lenten and Jan Libich say that with a cash rate of 2 per cent, the standard 25 basis-point cut becomes huge in relative terms, which creates problems in a low-rate environment.
 
Once levels fall below 2 per cent, the usual 25 basis-point adjustment can create problems because its non-divisibility will mean (for example) that the RBA will not likely cut further (if really needed) to 1.75 per cent, while they would be willing and able to cut to 1.90 per cent.
 
The current regime will likely result in a loss of signalling value of monetary policy, and thus the change will allow the RBA to get more 'bang for the buck' out of a rate reduction.
 
Lenten and Libich believe that should rates fall to 1.50 per cent by the end of the year as some predict, then the cumulative expansionary effect on the economy will be greater from 5 x 10 basis point reductions, rather than 2 x 25.
 
Other benefits will include increased responsiveness to events that require tailored monetary policy attention, such as a possible looming real estate bubble, particularly in Sydney.
 
They add that changing to 10 basis point increments would also be consistent with the vision of monetary policy by former Bank of England governor Mervyn King, who said:
 
'A successful central bank should be boring – rather like a referee whose success is judged by how little his or her decisions intrude into the game itself.'
 
Contact: Liam Lenten tel: 03 9479 3607 or 0417 562 959

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