Steering Wheels

Grip on steering wheel may be all Mboweni has
Policy decisions are based on guesses - because everyone's take on life is different and no one's version of reality is reliable.

Often they are educated guesses. When Reserve Bank governor Tito Mboweni and his monetary policy committee (MPC) make a call on interest rates, their decision could be called a very educated guess, based on vast quantities of the best available information.

But the best available information just isn't good enough. For a start, it's out of date before it reaches the governor's desk.

US Federal Reserve Board chairman Ben Bernanke dealt with this and other problems facing central bank governors in a speech in December 2004, long before his appointment last year as chairman.

He compared driving monetary policy to driving a car with "an unreliable speedometer, a foggy windshield and a tendency to respond unpredictably, and with a delay to the accelerator or the brake".

He explained that the data are available only after a lag, and that collecting and collating it is an imperfect process. So it's very difficult for anyone to determine precisely where an economy is in the cycle at any particular point.

It's also impossible to know whether the key central bank rate is at an appropriate level.

That's because "a family decision to buy a new home or a firm's decision to acquire new capital goods depend much more on longer-term interest rates - mortgage rates and corporate bond rates - than on the Federal funds rate", said Bernanke.

And long-term rates, in turn, depend on how "financial market participants expect the Federal funds rate and other short term rates to evolve over time".

So the process is circular.

In the circumstances, Bernanke said, driving monetary policy was like driving "a car whose speed at a particular moment depends not on the pressure on the accelerator at that moment, but on the expected average pressure on the accelerator over the rest of the trip".

That's as scary as finding out the bus driver left his glasses at home and borrowed a pair from a passenger.

The theme of uncertainty was picked up last month by Federal vice-chairman Donald Kohn. Forecasts of inflation, reflected by financial market movements, "only give us a sense of where inflation is expected to go, not why it is going there", he said.

His point was that, unless the central bank knows what is driving inflation, it can't decide on the appropriate policy move.

Of course, the greatest unknown - that central bankers know they don't know - is when monetary policy will kick in.

There is a lag before changes in interest rates affect borrowing and spending. But no one is sure exactly how long it will take, or how sharp the response will be when it comes.

Households and businesses can't immediately change course; moreover, if they did, the move might be too sharp.

And the process might have to be abruptly reversed.

Chris Stals, Mboweni's predecessor, once admitted that making monetary policy decisions was like launching an unguided missile and hoping it would arrive at the right spot.

A tiny error in the launch angle and it would overshoot its target by many multiples, he said.