This post began as a critique of yesterday’s RBA release of its discussion paper: Asset Prices, Credit Growth, Monetary and Other Policies: An Australian Case Study. The study is in large part an examination of the Macfarlane RBA’s attempts to “lean against the wind” in 2002 and 2003 as an Australian asset bubble emerged. The paper draws the diffident conclusion that Macfarlane’s efforts probably burst the bubble. Macfarlane has basked in the glory of the same apocryphal truth for the past decade, enjoying a reputation as the first and only central banker to address asset prices.
But what happened when this blogger delved into the data was a jolt to the memory stick. In looking at the above table, it is obvious that once past the early nineties post-recession rebound, the main credit and asset growth story can be dated virtually from the month of Macfarlane’s appointment to the RBA in September 1996. Tellingly, the official interest rate was 7% in August of that year. By December it was 6%. By July the next year, it was 5%. In addition, the spread between the official rate and bank rates had also diminished another 50 basis points as competition from multinational and non-banks crimped the big four’s margins.
And look at what happened in the chart below. 1996 dates the sudden upwards shift in long-term income to price ratios from around 3x to above 4x. Rates spiked briefly through 2000 but were back to below 5% in 2002. This helped along the second leg up in income to price ratios to above 5x (which was also fired up by the First Home Buyers Grant).
Now, there was a new Conservative government from 1996 crimping fiscal outlays to pay down debt. And Australia was still enjoying its productivity surge from the reforms of the late eighties through the mid nineties. From mid 1997 we also faced the Asian financial crisis, which played a role in keeping interest rates low right through until the early 2000s.
And yes, inflation rates were subdued during the periods when Macfarlane cut rates hardest.
But by way of comparison, when, in 2000, Australia faced four consecutive quarters of GST-induced inflation above 6%, official rates peaked at 6.25%. Whereas, in 2008, under Glenn Stevens, when Australia faced three consecutive quarters of commodity-price induced inflation from 4.5% to 5%, rates peaked at 7.25% with another 50 basis points added for real rates as banks widened the spread.
If the RBA is going to credit Iain Macfarlane and itself with successfully “leaning against the wind” in 2003 then shouldn’t it also acknowledge his and its role in the creation of that very same gale?
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
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