No support for Dickens' theory the OCR should be held steady

Economist Rodney Dicken's theory that the Reserve Bank should aim to maintain its official cash rate (OCR) at a neutral level through the business cycle isn't finding any support from other economists.

Wednesday, June 29th 2011, 8:37PM

by Jenny Ruth

Dickens argues the central bank's current method of setting the OCR (and the same method used in Australia, Britain, the US and Europe) by forecasting how the economy may develop is a major source of economic instability.

What he calls "the grand old Duke of York approach to running monetary policy" sees the Reserve Bank marching interest rates to the top of the hill only to march them back down again.

"The result of the Reserve Bank's fine tuning of interest rates and its experiments has been massive instability in residential building activity," Dickens argues.

The Reserve Bank's approach is "a scam because the central bank has been a major, if not the primary source, of instability in the economic environment."

If the central bank played a much more passive role by aiming to keep the OCR at a neutral level, the housing market, economic activity, wholesale interest rates and the currency would all be more stable than they are, Dickens says.

The one economist who had actually read Dickens' paper, rather than just newspaper reports on it, says like other suggestions of alternative ways to run monetary policy, Dickens' comes from left field.

"There's usuallly a reasonably strong prejudice against these kinds of ideas that in most circumstances is justified," the economist says.

Monetary policy is probably one of the most considered issues of the last 30 years and there's "a very, very large mainstream literature," he says.

Another economist says while it's healthy to discuss how monetary policy could be run better, Dickens' argument over-simplies the situation.

While Dickens has argued in previous papers the Reserve Bank has a very unreliable record on forecasting, other economists say the central bank's record is as good as, if not better than, most.

A common criticism of Dickens' theory is keeping the OCR steady wouldn't do away with the business cycle and would simply make other aspects of the economy, and probably the currency as well as inflation, even more volatile.

"We're more likely to have a boom/bust cycle," one economist says.

Following Dickens' approach during the housing boom wouldn't have been sensible, he says.

"To avoid having a boom, you have to have the economy being stable pretty much all the time. That would be quite a challenging job."

Another economist says leaving interest rates stable "means not having monetary policy."

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