Instrument Insufficiency and Economic Stabilisation

Recently concerns have been raised about the effectiveness of monetary policy in controlling inflation while avoiding damage to the economy from high exchange rates. This paper examines the basis for concern and identifies the problem as a failure in the primary instrument, namely the Reserve Bank's operating cash rate, to adequately impact further along the term structure curve, which has become the more sensitive area for aggregate demand. This means that direct control over expenditure is weak, and too much leeway is left to the housing and other asset markets to sustain demand in the economy. Globalisation of credit availability and financial technology have helped to blunt the policy instrument in this respect, shifting the adjustment burden on to the exchange rate. Deft management of interest and currency expectations can help, but the problem may require closer coordination and cooperation between monetary and fiscal policy, restoring a stabilisation role for the latter.