The reason behind central bank's efforts to maintain interest rate

By Gerv Tacadena

RBA is prioritising financial stability concerns in its recent interest rate decisions

It looks as if the Reserve Bank of Australia (RBA) is trying to mitigate risks to financial stability than to keep inflation in check with its recent interest rate decisions.

During the monetary policy meeting of the RBA board in February, the central bank explained that the steady interest rate decisions were partly due to the understanding of the possible risks to financial stability.

In a think piece on The Conversation, University of Sydney's Stephen Kirchner said the decision seems to be off with what the central bank otherwise has to say about underlying fundamentals of our economy.

"It correctly blames trends in house prices and household debt on a lack of supply of housing, and not on excessive borrowing. These supply restrictions amplify the response of house prices to changes in demand for housing," Kirchner said.

Furthermore, zoning boosts the marginal cost of houses in Sydney by another 73%, central bank research revealed.

Kirchner said the restrictions on lending by the Australian Prudential Regulation Authority (APRA) since the end of 2014 was meant for the housing supply to keep up with the demand and to protect households from future shocks.

"The RBA argues that it needs to balance financial stability risks against the need to stimulate the economy through lower interest rates. But this has left inflation running below the middle of its target range and helps explain why wages growth has been weak," Kirchner said.

Also Read: RBA keeps cash rate untouched for 19th consecutive month

Australia's official cash rate has been held steady since August 2016 -- the longest period of interest rate lull. Unlike in the United States where long-term interest rates continue to soar, those of Australia have languished. This gives an impression that the Australian economy is projected to underperform in relation to the United States.

With this, inflation expectations have been stuck in 2% over the recent years, below the desired average of 2.5%.

"Inflation has been below the midpoint of the target range since the December quarter in 2014. On the RBA’s own forecasts inflation isn’t expected to return to the middle of the target range over the next two years," Kirchner said.

Kirchner explained that below-target inflation makes Australia less resilient to economic shocks. And in case a shock does occur, the subdued economic growth and inflation would give Australia a weaker support.

"If the RBA continues to sacrifice its inflation target on the altar of financial stability risks, inflation expectations and wages growth will continue to languish and the economy underperforms its potential," Kirchner said.

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