Over the past few days there has been much debate on this blog, and articles at less credible media outlets, that have accused the RBA of having stuffed up by easing monetary policy over the past six months. These arguments hinge upon the big first quarter GDP number and yesterday’s solid employment report.
Many of these arguments have come from a discredited bullhawkian point of view, that Australia faces an imminent inflation threat, which has been wrong now for a year and a half.
One reason that these pieces should be seen as rhetorical, is that none of them reference the fact that the RBA cuts themselves were a large reason behind the first quarter surge in growth in the first place. Anyone watching the data rather over the past year will have noticed that there has been a strong correlation between the jawboning of rate cuts, as well as cuts themselves, and rises in retail spending. This was obvious last July when Bill Evans brought relief to the bullhawkian inflation panic and retail sales jumped. And, as we know, the first quarter GDP figure was largely driven by the biggest jump in household consumption since 2007. That reeks of pent-up demand unleashed by rate cuts, as well as, no doubt, a more positive environment following the temporary relief of Europe’s LTRO.
But the question does remain, has the RBA gone too far by cutting rates again this month? In my view, absolutely not. There are four reasons why, two structural and two cyclical.
The first structural issue is closely related to the above point. Take a look at this 6 month chart of cuts and retail spending:
On both occasions when sales bounced following rate relief, the pulse faded rapidly. You could point the finger at developments in Europe or China or Timbuktu to explain this but it doesn’t really matter. They are all a part of the same phenomenon, the new normal of Western deleveraging, which has many years to run. Australia has its own version of this process under way in the dramatically lower rates of credit accumulation on display in personal and mortgage credit.
I contend that this backdrop means that households have an underlying psychology to save or pay down debt. When rate relief arrives, it thus provides a quick boost of spending exuberance which gives way quickly to the underlying conservative drive.
This, it seems to me, actually reverses some of the traditional impacts of monetary policy. Instead of new demand building into greater inventories, investment and jobs over time – the classic six month delay to rate cut impacts – we have a sugar hit that passes quickly as a lack of new borrowing peters out in swamp of overcapacity on the production side on the economy.
Many point to national accounts statistics that show household consumption is still strong (in services they argue) but that is clearly beside the point. It is inarguable that retail and housing are under pressure because aggregate household demand is unable to support the supply available in consumer facing industries. As such, the RBA is now in the business of managing a number of declines in previously growing and large employing sectors. Rate cuts are about supporting demand to prevent them slumping too quickly.
The second structural reason why that the RBA did the right thing by cutting this month is that the mining boom is not delivering the widespread growth that the Bank anticipated earlier. As Deputy Governor Phil Lowe said recently:
The overall conclusion from this work is that given the huge pipeline of mining investment and the current relatively low unemployment rate, it is likely that conditions will continue to vary significantly across industries for some time to come. This work also serves as a reminder that improving productivity growth remains the key to strong output growth in the non-mining-related parts of the economy. It also suggests that there is some scope for non-mining-related demand to grow a little more quickly than has been the case in the recent past.
That was a signal that some of the of the tightness in monetary policy that we’ve seen for eighteen months, which was designed to “make room” for mining to grow without inflation by slowing other sectors, can be released.
Which brings us to the first of the cyclical reasons for why the RBA was able to comfortably cut interest rates again this week: low inflation. Another irony of the bullhawkian critique of the RBA for cutting rates unnecessarily because of high first quarter GDP is that the GDP figure itself was heavily boosted by a 1 per cent deflation figure in the national accounts deflator. In short, the only reason the bullhawkian critique is possible is because it isn’t, which threatens the proverbial disappearance in a puff of logic.
Of course I am aware that there are inflationary pressures in the Australian economy in the mining related industries and non-tradable sectors. But in sum, which is what matters, there is bugger all inflation at the moment. In fact, it’s pretty much the lowest median figure we’ve seen since the mining boom began in 2004, as shown in the following monthly chart:
The fact is, however, that if inflation were to rear its head again, the RBA could reverse a cut or two and, as had been made clear in the past few days, global speculators would do the rest by piling into a rising dollar and restoring very deflationary conditions to the economy.
Which touches on my last cyclical point. The RBA has very sensibly taken out some insurance against a worsening in the global economy and markets by cutting in June. As was shown this week in a rapidly deteriorating series of PMIs everywhere, global growth is on the slide. The terms of trade have already been hit and the danger remains of significant further downside. If such happened, it would hit mining hard. You simply do not want to enter that kind of event with the rest of your economy on its knees, as was obvious in April and May. To put it another way, a little extra pace in the slow half of the two speed economy is a good thing when the fast half faces an imminent threat.
The RBA did not screw up.
