Does the Reserve Bank need a reality cheque?

So continuing on from last post on the the PPoD I saw an article today discussing the Reserve Banks recent rate rise and their take on the PPoD. This is perhaps most succinctly expressed with a quote from Tuesday's rates announcement.

"To date, there has been very little contagion outside Europe" Glenn Stevens

It is almost as though the market itself heard these words and decided to prove him wrong. Just two days later the DOW plummeted and over the course of the ensuing 4 days the global markets lost around 10%. Of course this is ridiculous, the reality is of course that there is a lack of understanding of the wider impacts of global debt servicing problems across the board.

Or rather it is not that there is a lack of understanding, it is that there is a distinct lack of the ability for existing forecasting and modelling to handle such discontinuities as a Greek default on debt, or an unpronounceable volcano grounded all  aircraft in Europe, or the Federal Reserves printing press breaking and throwing their currency devaluation plans into disarray (more on this in a future post).

The problem really arises from the fact that it is nigh on impossible to firstly predict events, such as a volcano or an accidental order to sell ten times as many shares as planned and secondly to predict the markets reaction to these events. The initial prediction can for the most part be covered by the traditional assumptions of randomness and probably bludgeoned into submission with some Monte Carlo simulation, the real difficulty comes with assessing the impacts of the initial event.

So, what is the Reserve bank to do? It would seem to be that they would be better off being over cautious in the current climate than over zealous. This will probably mean that we have seen the last rate rise for a while indeed, we may be at an inflection point, where we are not climbing out of the original recipe GFC but falling into the grasp of the second "Zinger" financial crisis which will be spurred on by the collapse of countries under high debt loads. They may have stumbled through the last crisis only to succumb to a second wave of market doubt and volatility.