Modelling the Reserve Bank of Australia's Policy Decisions and the Case for a Negative Cash Rate

Taylor's eponymous 'rule' models how central banks set policy rates in response to inflation and output. We estimate a Taylor rule for the Reserve Bank of Australia (RBA), modifying it to make it more realistic, while retaining its simplicity. The model implies that if the Bank responds to recent forecasts as it has on average since 1995, the cash rate could have briefly gone negative in 2020. But the RBA is wary of negative cash rates. There are grounds for caution; the economic outlook is particularly uncertain and the economy's response to negative rates is unchartered territory.