Innovative Australian research can stabilize the world economy
Jun, 2009
Ground-breaking Australian research is going to provide central bankers with far greater control over their country's economy.
By applying advances in statistical analysis to macroeconomic policy, Australian-led research is set to have a huge impact on the future stability of both local and international economies.
The two year research project, which has just received an ARC Linkage grant of more than $170,000, is being led by Shaun Vahey, associate professor in economics at Melbourne Business School. MBS is being partnered in this research by the Reserve Bank of Australia, the Reserve Bank of New Zealand and Norges Bank.
He says, "There have been a number of advances in statistical techniques and this project will move those advances into macroeconomic policy area for the first time.
"The project is designed to address structural measurement problems routinely confronted by central banks. Policymakers at the Reserve Bank like to refer to things like the output gap and core inflation.
"These concepts are central to how they set interest rates, but they are not things that they actually have any hard data on, so they are called unobserved variables," he says.
"Our project will provide central bankers with more precise and detailed information about these variables. For example, typically they work with one particular measure of the output gap. Our technique will use multiple measures which can then be averaged out to provide a more precise measure. So they would get an average output gap, and a distribution about that central measure." Vahey added, "We will be able to tell them the probability of a particular value for these variables. For example, the probability that the economy is below potential output."
Setting interest rates with greater precision will provide central bankers with the ability to more finely tune the economy. Vahey says, "If policymakers had better information, they would have a lead time on what's happening with the economy, allowing them to move earlier, and with greater precision."
The Reserve Bank sets cash rates which affect interest rates on everything from small business overdrafts to household mortgages and credit cards.
Monetary policy is often described as a blunt tool. Vahey believes these techniques will sharpen the tool so that the Reserve Bank can fine-tune the economy-by not putting interest rates up too high and causing a recession, and not putting them too low and causing inflation.
Shaun Vahey, Associate Professor in Economics, is leading a team that has been awarded an ARC Linkage Grant for $176,130, for the project "Helping Central Banks Measure Unobserved Variables Using Real-time Forecasts". Linkage grants are awarded to university researchers who are working with partner organisations, and the set up costs can be considerable.
