Reserve Bank governor Phillip Lowe (Image: AAP/Joel Carrett)

The Reserve Bank (RBA) has made a major change in monetary policy with significant implications for the timing of interest rate movements in years to come. In effect, the bank has turned its back on old, established ways of reacting to events in the economy.

For years now central banks, including the RBA, have run monetary policy on the basis of what current data suggest might happen a little down the track in regard to their charter objectives — in the RBA’s case, inflation and employment.

The banks and many economists have come to rely on inflationary expectations as a key metric — surveys of consumer sentiment (where questions about likely future price movements are asked), pricing through inflation linked bonds (such as those in the much watched TIPS, or Treasury Inflation-Protected Securities, market in the US) and feedback from businesses in regular surveys.

In a virtual speech on Thursday, RBA governor Philip Lowe signalled that was changing.

In terms of inflation, our forward guidance has been forward looking — we have focused on the outlook for inflation, not just current inflation. This was a sensible approach when the inflation dynamics were relatively stable and well understood. In today’s world, things are much less certain. So we will now be putting a greater weight on actual, not forecast, inflation in our decision-making.

So the new approach is all about the actual, not the forecast.

In terms of unemployment, we want to see more than just ‘progress towards full employment’. The board views addressing the high rate of unemployment as an important national priority. Consistent with our mandate, we want to do what we can do, with the tools we have, to ensure that people have jobs. We want to see a return to labour market conditions that are consistent with inflation being sustainably within the 2% to 3% target range.

This means, as Lowe said on Thursday, that the RBA will not move rates until inflation is actually, not forecast to be, within the target range, and for some time. Likewise the fall in unemployment will have to have happened and be sustained — indeed, “a tight labour market”.

Unsurprisingly, the board thinks that’s “years away.”

Why the change? The RBA is clearly frightened that if it continues to use inflationary expectations as a basis for changes in monetary policy (tightening especially), it could choke off a tentative recovery and gathering fall in jobless numbers just as those gains are making headway.

There’s some central bank history at work here. The US Federal Reserve tightened monetary policy in 1937, which plunged the US economy back into a second depression. That rate rise was based on misplaced fears about the pace of recovery from the Great Depression earlier in the decade. That example has remained with central bankers for generations.

The RBA itself made the same mistake in 1994 when it lifted rates three times for a total of 2.75 percentage points. At that point, unemployment was still above 9%. Paul Keating rightly bears a grudge about that to this day.

It further cements the message that, regardless of whether there’s another tiny rate cut left for the bank to make, the next rate rise is off in the distance in the mid-2020s.