Over the past several years, the RBA, and some of its former staff, have engaged in a quiet reassessment of their role in the pre-GFC build-up of destabilising levels of debt in the Australian economy. There are a number of examples.
There is the late 2009 confession by Ian Macfarlane’s former deputy, Stephen Grenville, that the “efficient market hypothesis” – the idea that markets always perfectly priced – was bunkum.
In November last year, Glenn Stevens confirmed this repudiation in Senate testimony and went further still, declaring that we had enough debt and that central banks should tighten early in, and lean against, economic cycles, amongst other things.
Soon afterwards, Assistant Governor, Phil Lowe, delivered a speech that intrinsically reassessed the wisdom of Ian Macfarlane’s rate cuts through the late nineties and millennium, when Australia was enjoying the fruits of a productivity shock:
What then is the right monetary policy in this economy? In a world in which the setting of policy is determined solely by the two-year-ahead inflation forecast, the answer may well be to lower interest rates. If inflation is forecast to be below the target midpoint in two years time, lower interest rates, at least for a while, would help get inflation closer to target.
But would lower interest rates be the best response? To answer this I would need to tell you some more parts of the story. If asset prices were rising very quickly, investors were exuberant, and the financial sector was making credit liberally available, then lowering interest rates simply to hit the inflation target at one specific point in the future may not be the best response. Experience has taught us that low interest rates at a time of rapid increases in leverage and asset prices can pose significant medium-term risks to the outlook for the economy and for inflation. Ignoring these risks, and making leverage cheaper by lowering interest rates, simply to ensure that the short-term inflation forecast was at the target, is unlikely to be the best policy.
By implication, we assume, the Macfarlane RBA should take its share of the blame for the debt bubble.
Recently, current Deputy Governor, Rick Battelino, delivered a speech that for the first time admitted that the RBA did not successfully burst the Australian housing bubble in 2003, as is folklore:
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.
Then yesterday, Governor Stevens delivered his fighting speech on the benefits of mining and why you should stop whining about the shift away from yesterday’s easy-living:
The average consumer in an advanced economy is effectively experiencing a decline in purchasing power over food, energy, and raw material-intensive manufactures. Australian consumers face this to some extent as well. Were Australia not a producer of raw materials, we would be experiencing a good deal more of it. In such a world, there would be no resources sector build up. Our currency would be much lower. We would be paying much more for petrol at the pump, for our daily coffee and for a wide range of other consumer products. We would not be holidaying overseas in our current numbers.
We would have more of some other forms of economic activity that we currently have less of – we would, perhaps, be less of a ‘multi speed’ economy. But it’s unlikely our economy overall would be stronger. As it is, the rate of unemployment has seldom, in the past few decades, been much lower than it has been recently. Moreover, in that alternative world the real income of Australians in aggregate would be a good deal smaller.
But Australia is a resource producer, so we have the advantage of being able to take part in the additional supply of things that are in strong demand. This helps our incomes. Mining companies are doing their best to capitalise on the increase in demand, and the effects of this will flow through the economy, but other producers are also enjoying a boost to their income. Rises in the global prices of rural commodities over the past couple of years have been sufficient to deliver higher prices to most farmers despite the appreciation of the Australian dollar.
The message is quietly delivered but no less clear for its gentility: the Macfarlane years were a mistake. It’s time to toughen up as we become a fair dinkum capitalist economy.
