Deputy Governor of the RBA, Rick Battelino, gave a speech this morning that has left me kind of perplexed. The structure of the speech first described the surge in mortgage credit in Australia since the millennium and how much of it came from offshore borrowing in the banks. Second, it described how the banks had shifted to local deposit funding since the GFC, and third, it reasoned that the ongoing conservatism of savings habits would be sustainable (a clear rebuke for Moody’s).
I have no beef with any of this. What I found a little bizarre is how the RBA (or the Deputy Governor anyways) sees itself in this history. On the first question, of why it was that Australian banks borrowed so much dough offshore, Battellino said:
This funding model was well suited to the market conditions of the time. Banks had little difficulty in raising funds in wholesale markets, due to the weight of money seeking investments in Australia. In fact, it could be argued that the whole dynamic was driven by this flow of offshore money wanting to come to Australia – i.e. banks were offered ample amounts of funds by foreigners, which they in turn lent domestically, causing an increase in spending, a reduction in saving, a slowing in deposits and a widening in the current account deficit. This is a situation not dissimilar to that faced by the United States over the past decade, which Federal Reserve Chairman Bernanke has described indetail in his explanation of the global savings glut.
OK, so because China saves, the rest of us must spend. This argument is right at the macroeconomic level. After all, the accounting identities across nations must balance. But it has always struck me as somewhat perverse that we see ourselves as helpless in this. In the US the idea has some grounds because the structure of its mortgage market – mostly fixed rate, tied to the 30 year Treasury rate – meant that mortgage rates were directly affected by Chinese savings buying Treasuries. This was Greenpan’s “bond market conundrum”.
No such problem exists here. The RBA prices our credit. If they’d made it more expensive over the period since the millennium then guess what? We probably would have borrowed less. Houses would have gone up less. And, as a result, we would have spent less, as the Unconventional Economist illustrates so beautifully today. There would have been less current account to fund.
The RBA enjoys a sterling reputation in part because of Ian Macfarlane’s success in doing just this in 2003 when the Sydney housing bubble was getting out of hand. This ‘leaning against the wind’ success story is an article of faith monetary circles. In fact, Battellino makes reference to that period in his speech:
In the early part of last decade, those pockets were heavily concentrated around the south-west parts of Sydney. These problems followed the very strong rises in Sydney house prices over 2002 and 2003. They were linked to a sharp rise in loan approvals, some lowering of lending standards, particularly by second-tier lenders, and increased speculative activity. Conditions in that region subsequently improved, helped by a period of stable house prices and rising incomes, though the process took a long time and the arrears rate in that part of Sydney remains higher than the national average.
Recently, it has been parts of Queensland and Western Australia that have shown a deterioration in loan arrears, albeit from low levels. As had been the case in Sydney earlier in the decade, the recent increase in loan arrears in these states followed a sharp increase in housing loans and unusually strong rises in house prices between 2006 and 2008. Some part of this was justified by the emerging resources boom but, as had occurred earlier in Sydney, this was accompanied by some lowering of credit standards and increased speculative activity, with the result that some households over-extended themselves. Adding to the stress on household finances was the fact that both these states though again from relatively low levels.
Bravo. This is the first time that I’ve seen the RBA confess that the housing bubble extended beyond 2003, even if it is doing so in a rather oblique way. Again, however, one has to ask, where’s is the RBA in this equation? It priced credit from 2005 to 2008. It made it cheap in the GFC. And over the past eighteen months it has made it expensive again. Thus, parts of the economy are now finding it hard to pay their bills. This didn’t happen by itself, did it? They wanted it to happen, right?
The RBA is again absent when Battellino discusses ongoing consumer caution:
In the current environment, it is unlikely that households will have much enthusiasm for increasing indebtedness. The most likely scenario is that household borrowing will continue to grow at a relatively subdued rate for some time yet. From the Reserve Bank’s perspective, this would be a welcome development. It would allow the period of consolidation in household balance sheets to continue and would avoid households adding to pressures in the economy at a time when its productive capacity is already being stretched by the resources boom.
It’s like the central bank is some passive observer, like James Joyce’s portrait of the artist as a young man, quietly paring its finger nails as it watches ordinary mortals go about their business.
I’ve no doubt that consumers imbibed a very strong message from the GFC. But that message has been rammed home by Glenn Stevens repeatedly and the bank has made it abundantly clear, in speech after speech, minutes after minutes, that an incautious consumer will be punished with higher interest rates.
I understand the RBA operates on a “least harm” policy vis-a-vis the economy. That they like the private sector to make its choices, and I agree. And, there’s no doubt that the economy has a life of its own (especially at the moment) and that the RBA is more shepherd than sheep. But equally, the power to price credit is a pretty big deal in the real economy.
What about that simple old-fashioned notion that a central bank is there to take away the punch bowl when the party gets out of hand? They did it 2003. They didn’t do it from 2005 to 2008 and let the housing bubble go national. But are doing it again now.
They may get it wrong, may already have done so, but so what? Transparency is much more useful than invisibility.
P.S. Here’s a more traditional take on monetary policy from former Assistant Governor, Peter Jonson (AKA Henry Thornton). He has a new book out called Great Crises of Capitalism, which I thoroughly recommend.
