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RBA uncertainty around supply shocks complicates its hawkish stance

The RBA is trying to cool demand by engineering below-trend growth, but uncertainty about spare capacity and shock size makes it harder to judge how restrictive policy needs to be.

Reported · Written up by our desk · Central Banks

Action Forex argues that shocks can make it difficult to determine a country’s true economic position, especially when the shocks are supply driven rather than purely demand driven. In that setting, policymakers must infer how supply capacity is changing while also trying to separate the shock’s effects from the underlying growth trend.

The outlet says the RBA’s hawkish tone in recent months reflects its view that demand is outpacing supply, and that it is seeking a period of below-trend growth to bring demand back in line with supply. How far the RBA believes it must slow growth depends on how quickly Australia can expand without hitting capacity constraints.

Action Forex adds that supply shocks increase forecasting challenges because the data reveal movements in quantity and prices, which reflect both the shock and the trend in supply capacity. Since the magnitude of the shock and key estimates like trend capacity growth and the pre-shock starting point are not directly observable, misestimation can lead to incorrect attribution of price and quantity changes to either the shock or to slower supply growth.

The article further contends that several major adverse supply shocks in recent years were policy choices, including Russia’s invasion of Ukraine and US tariffs, and that the scale and form of such shocks are shaped by policymakers’ costs and constraints. It warns that if these shocks have grown more frequent or larger, extracting signal from noise becomes even more difficult for forecasters.

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