RBA shadow bolts door on ivory tower

From the RBA’s infamously wrong shadow today:


Contrary to the CAMA RBA Shadow Board, which on balance recommended a policy of no change, the Reserve Bank of Australia at its February meeting lowered the cash rate from 2.5% to 2.25%. The RBA pointed to a likely fall in economic growth over the next 12 months – around 2.25%, well below trend of 3% – as the main reason for lowering the cash rate. Weak labour market data confirms the soft economic outlook, and financial markets are anticipating another possible rate cut during the next few months. The CAMA RBA Shadow Board, however, on balance prefers to hold rates and still considers it necessary that the cash rate is lifted in 6-12 months. In particular, the Shadow Board recommends with confidence that the cash rate be held at its current level of 2.25%; the Board attaches a 64% probability to this being the appropriate policy setting. The confidence attached to a required rate cut equals 14%, while the confidence in a required rate hike stands at 22%.

Recent labour market data underline the cracks in the Australian economy: according to the Australian Bureau of Statistics the unemployment rate jumped to 6.4%, its highest since 2002. The seasonally adjusted labour force participation rate remained at 64.8% but wage growth is weak, 2.5% in nominal terms. Stagnant real wages will put the brakes on consumer spending and make it less likely that GDP growth ticks up again.

The fall of the Aussie dollar has halted at around 78 US¢. There are clear signs the weaker dollar is helping the domestic economy. However, the danger is that Australia is becoming embroiled in the global currency war, whereby countries loosen monetary policy in an attempt to gain international competitiveness. While feasible for countries individually, collectively the world as a whole cannot devalue (exchange rates are relative prices, not absolute prices), and consequently the world economy becomes inundated with liquidity, leading to all sorts of false price signals and economic dislocations. Such concerns underlie the scepticism towards further rate cuts.

Confidence measures remained mixed. Consumer confidence bounced back in February, with the Westpac Consumer Sentiment Index coming in at 100.70 this month (93.2 in the previous month). Business confidence measures remain largely unchanged, but the most recent estimate of capacity utilization dropped from 80.53% in December to 79.96% in January. As the economy is rebalancing and trying to come to terms with the many domestic and international uncertainties, consumer and business confidence measures will continue to lack clear direction.

The picture for the global economy looks much the same as in the previous month: Europe is weak while working through a plan to restructure Greek debt, China is steadying, while the US economy remains the only relative highlight in the world economy.

The consensus to keep the cash rate at its current level of 2.25% equals 64%. There is little confidence (only 14%) that another rate cut is appropriate whereas the Shadow Board considers it more likely (22%) that a rate hike, to 2.5% or higher, is the appropriate policy decision for this month.

The probabilities at longer horizons are as follows: 6 months out, the estimated probability that the cash rate should remain at 2.25% equals 31%. The estimated need for an interest rate increase lies at 56%, while the need for a rate decrease is estimated at 13%. A year out, the Shadow Board members’ confidence in a required cash rate increase equals 63%, in a required cash rate decrease 12% and in a required hold of the cash rate 26%.

More overly limited and idealistic clap trap. It is certainly the case that currency wars don’t help the world, but standing back on a point of principle and letting the world take your production is hardly a solution.

Houses and Holes
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  1. Joining in in the currency wars through loose monetary policy is hardly a solution either.

    If the AUD is overvalued, a solution is for RBA to print AUD and buy foreign currency. If necessary, for years (if necessary, alone! W/ apologies to WC)

    But we can’t have that – that’s interventionist, and we are pro free market. Except when it comes to interest rates.

      • “There are clear signs the weaker dollar is helping the domestic economy” Where?
        More chinese dudes buying houses?

      • “The world did not end when the $AUS slid down to under 50 cents US from the mid 80s to the end of the 90s and that is probably where it should have stayed.”

        Yes as to it should have stayed there. Howqever it didn’t. We ramped up the level of stupidity and leveraged up the risk and distortion. Now we have a REAL problem.
        History is worth a think about in relation to that era. The opening up of Eastern Europe and the rise of China helped offset our fall in the exchange rate. Can technology do the same thing for us this time? – Maybe! Alternately technology will bring us many problems which we don’t seem to be of a mind to sensibly solve.

    • Peachy,

      That’s about the sum of it.

      Neo-liberalism is keen on free this and free that but not

      1. The price of debt. They like that kept lower than it would otherwise be so the risk takers get a free ride. Coke would be over the moon if the govt intervened in the price of fizzy drinks by forcing non drinkers to subsidise the price of the sugary gunk.

      2. Keeping an economy and its production capacity defended from attacks by currency warriors armed with ‘cheap money’ boarding axes and ram engines built by off shore central banks.

      The shadow board are on the money but they leave themselves open to ‘what about the children’ attacks by not explicitly explaining how an economy can easily defend itself from currency warrior attacks WITHOUT the price signal destroying madness of manipulated debt pricing.

      Unfortunately, the explicit explanation involves questioning the basic model of economic management and that is still a no go zone for our fearless policy wonks.

      1. Regulate unproductive capital inflows.

      This will immediately put downward pressure on the exchange rate.

      2. As interest rates rise, which they will as the unproductive inflows are slowed, soothe the deleveraging economy with fiscal deficits.

      Not necessarily more spending – tax cuts are best. The best would be to de-pork while cutting taxes. People are more than capable of pointing money where it will do the most good for them and their families.

      3. Print at least some of the deficit.

      This is not an option – a deleveraging economy means a shrinking money supply. Printing is essential to limiting a deflationary bust as asset prices adjust.

      • Peachy

        We have to have capital controls. It is the ONLY way this problem can be solved.
        Printing A$ and buying foreign currency just leaves foreigners with more A$ to come and buy our assets cheaply. We gain nothing.

        If we have capital controls and print the decline in our currency will be sharp indeed – what would anyone want our currency for? Given that we ruin a chronic CAD there is NOTHING, on balance, that anyone wants to buy with the extra A$. Now the CAD is not a fixed number but we cannot magically produce new goods as easily or as quickly as we can print the A$. So really your proposal doesn’t wash. – sorry!

        We MUST have the capital controls – there is no other way around this.

      • Printing and proper capital controls are mutually exclusive.

        We cannot print the deficit without lining up what assets we are going to sell to fund the printing. In our economy, structured as it is with all its anti-productive culture and rigidity, with zero to negative RAT rates, deficits will, by definition, pretty much all end up in external account.
        So please would those who advocate printing to fund deficits also please post what assets you plan to sell to foreigners to fund the printing.

      • Flawse,

        You do not need to sell ANY assets when you print a deficit.

        You only have to sell assets when you are printing a deficit IF you want to maintain the value of the currency while printing.

        If you DON’T sell assets which is what capital inflow controls are all about – limiting the capacity of locals (private and public) to sell IOUs and other assets off shore – AND you are printing your exchange rate WILL depreciate.

        That is the point of the exercise.

        What I don’t understand is that when I point this out you insist that the economy cannot cope with a depreciating currency and thus more competitive exchange rate.

        My response is that it will because it will have to and if the process I describe is managed it can take place over a 5 – 15 year period.

        The world did not end when the $AUS slid down to under 50 cents US from the mid 80s to the end of the 90s and that is probably where it should have stayed.

        You keep overlooking the incredible deflationary forces that must occur when interest rates rise and people start to delever.

        I can understand why you don’t think the money supply should expand like a hot balloon like it did during the credit boom (and I agree with this) but I don’t understand why you would want it to shrivel up like a sultana which is what it will do when people start to delever if the govt is not printing a deficit to maintain the money supply.

        If you introduce capital inflow controls and don’t print you WILL get a depression.

        Sure, the politicians and most of the economists have still not accepted the full implications of a broken Debt Machine but they will have to as they cannot just ignore it.

        It is dead and is preparing for the choir celestial.

      • pfh
        I cross swords here reluctantly. I know you and I have been on teh same side of this argument since wqay back. However you have thrown a couple of rocks here which need defending against. (Your occasional tendency towards MMT thinking is a worry! 🙂 )
        If you think I am saying that an economy can’t cope with a depreciatoing exchange rate you are not reading what I am saying. However if it is to cope we need to start facing FACTS.

        There is no doubt if you print that your exchange rate WILL in fact depreciate. No doubt about that at all. Make no mistake here that what the RBA does when it lowers interest rates is print money and drop it in the market. In my view, and yours I think, from a macro point of view we can conflate the RBA and Govt. So it doesn’t matter much whether the govt is running a deficit or the RBA is printing money to maintain negative RAT and over-consumption.
        So absent any other changes where does the printed money flow to? It doesn’t go back to government because you are intent on your deficit. (Now I know there maths on that are a bit more complex but fundamentally it holds true in the position we find ourselves) It doesn’t get saved because we are intent on running negative RAT rates. It just makes your CAD worse and all your debts harder to repay.
        It’s alright to say this is what I want to happen. That does not mean it WILL happen.The virtuous circle you describe just does not close. You are trying to print to make up for your reduction in the capital inflaow. However given that your printed money will very largely end up in imported goods how do you pay for them? Nobody will want your currency anymore because they can’t buy assets with it. What is going to magically ramp up into production? – As above we can print a bloody lot faster than we can raise production.
        If you don’t think your printed money is going to end up in imported goods I want to see the demonstration. Show me a model where, in the face of a chronic CAD and badly distorted economy, your government runs a deficit, where you ban all savings through negative RAT, that the printed money does not end up as foreign debt and asset sales. Now you MAY, if everyone was thinking correctly, send you deficit money solely in the direction of infrastrucutre that is basically aimed at increasing exports. However you build the thing NOW – your payback period is likely to be 20 years! Meanwhiole the money goes through your economy and into imports.

        We can’t have a reduction in capital flows AND maintain the present economy. You have to balance that external account. That’s a simple fact.
        So If you want to close that circle you have to SAVE. The money you WERE getting with your foreign borrowing and asset sales has to be made up somehow or you have to start immediately exporting like crazy…but how?

        So, as you said, interest rates will rise as soon as you pressure the foreign capital flows. That’s just a fact. If you run your deficit to offset that you ‘soothe’ the domestic economy you are printing enough that interst rates don’t rise and you have no saving.
        For simplicity for the moment conflate the govt and private sector into one sector (let’s call it ‘domestic’ )and then think about the interaction of that sector with the extenal sector.
        If you cut the funds from the external sector your domestic sector MUST save. There is no choice here. It just doesn’t work otherwise – the ends don’t meet!
        So how do you finance the blowout in imports that your deficit produces?

        Everyone keeps making up economics to fit the naive fairy story that we can painlessy correct all the misallocation and distortion of the past six decades. Such misallocations and distortions include
        – We have damned all secondary industry left and of what is left it is oriented domestically.
        – We’ve done our best to smash rural industries, communities, and people for 60 odd years. We’ve been reasonably successful!
        – We have an education system designed for the present economy – lots lawyers, government jobs, restaurants coffee shops and retail. Some of the current Science education boggles the mind of an old scientist.
        – Our people all live in the wrong places – all living in a couple of cities on the Eastern seaboard that produce sfa and whose role is to earn ‘fees’ from productive industries elsewhere by creating difficulty and over-government
        – We all have an expectaion of lifestyle that is based on over-consumption and resultant debt. That IMO opinion cannot be changed and if it can it will be damned difficult and I want someone to tell me how!
        – As you point out above (the explicit explanation involves questioning the basic model of economic management and that is still a no go zone for our fearless policy wonks.) the whole economic philosophy of the country is mis-directed. The RBA Treasury Banks are all infected. What is even more of a problem is that our academic institutions have been teaching this b……t for 50 years that I’m aware of. How the hell do you change that??????
        etc etc etc

        So will the economy cope with a depreciated exchange rate???? Good question. You say that, by definition, it WILL cope. Sort of but I’m not sure ‘cope’ is the right word. There will be some ‘outcome’ which is inevitable – what that outcome will look like is what is open to debate. The idea that somehow, magically, we are all going to come out the other end of this with smiley faces and live happily ever after in this land of plenty is just fanciful.

        We should NOT try to portray this as easy.
        We should not keep pretending that difficult things will not happen because we don’t like the idea.
        We should NOT keep on inventing ever more dodgy economics to pretend that there is no real problem or, if there is one, it is easily and painlessly solvable.

      • Flawse,

        We are most definitely on the same side and those weren’t rocks, they were soft mangoes full of reason :).

        As for suggesting I am dabbling with the dark arts of MMT – that is a bit harsh! ;).

        Not sure that it is a virtuous circle but where you are causing yourself unecessation grief is the sequence of events.

        Without capital inflows you do not have a CAD.

        The sale of assets and IOUs precedes the purchase of trinkets. Because I did not personally arrange finance off shore before I bought my iPad does not mean it did not happen.

        The offshore purchase of my iPad depended on a capital inflow before I took delivery. Someone somewhere – probably a bank giving someone a mortgage – signed an IOU to someone offshore that ultimately allowed me to buy the iPad.

        Cut the capital inflows and you are cutting the CAD. People will not sell us stuff without getting something in exchange.

        Deficit printing will not change that. Printing does not allow you to run a CAD – only the capital inflows allow that. Printing does not produce capital inflows.

        However, deficit printing will devalue the currency UNLESS the forces of deflation due to the deleveraging process are balancing it out because the money being created is off set by the money that being destroyed by deleveraging.

        I am suggesting deficit printing to maintain currency stability not to devalue it (i.e inflation).

        Deficit printing whilst there is idle capacity helps more of that capacity to be used but it is no magic wand. When the idle capacity is exhausted inflation will result. In that event reduce the deficits.

        Deficit printing is only a problem when the private banks are pumping up the money supply in pursuit of their trailing commissions. When they are doing that inflation not only gets out of control it is very hard to manage.

        This is why endogenous money creation by private banks is a fundamental problem that must be addressed.

      • drsmithyMEMBER

        As for suggesting I am dabbling with the dark arts of MMT – that is a bit harsh! ;).

        I’m struggling a bit with this. How is what you propose not MMT ?

        (In layman’s terms please. 🙂 )

        (Though I’m pretty sure I understand why allowing endogenous money creation by private banks is bad.)

      • Dr smithy,

        At the risky of being swarmed by flying monkeys – I would put it this way.

        All I am suggesting is that as debt deleveraging shrinks the money supply a government wishing to maintain currency stability must maintain the money supply and that for most purposes means running a deficit. Especially if the endogenous money creating powers of private banks are prohibited.

        In my view such a deficit should mostly be the result of lower taxes rather than higher expenditure and it should be printed and not the result of unnecessary and sham debt issuance.

        The only thing any of the above has in common with what MMT fans support is the running of a deficit. Just about everything else they strongly disagree with including dismantling the central bank private bank cartel, capital controls, govt control of the money supply, ending private bank endogenous money creation etc.

        MMT suggests excellent reasons for fundamental reform of the current banking system but my impression is that MMT fans seem to want to keep it and just encourage govts to run deficits by spending – job guarantees etc.

        Not surprising that Flawse has problems with it – I do as well.

        MMT tries to work within the current ‘operational reality’ I reckon that is a bad idea as the current operational reality is too flawed to save.

        Of course my suggestions require a positive role though very limited and specific role for govt in economic management. This upsets all the free market small govt fans yet it also offends the highly interventionist welfare statists in which I include MMT. I think I am just very centrist which is a bit boring and old fashioned these days.

      • pfh Carts and horses.
        Deficit printing Unfortunately that is where your circle doesn’t close.
        Again, conflate the govt and private sector into a ‘domestic sector’ Now print or deficit whatever you want to call it. Where does the money go? It doesn’t go into savings! It doesn’t go into government! It goes into the external account spent on imported goods. You say the logic doesn’t matter because we cannot run a CAD. But if you print/deficit spend in a domestic economy you MUST have a CAD! Your circle doesn’t meet!
        You are trying to maintain the current economy while eliminating the CAD – that’s mutually exclusive. All you will do is pump money into those sectors already over-represented in this economy – retail, housing, Banking, restaurants etc- nothing is produced. You WILL get inflation in the said sectors. Tradable Inflation will have already run amok. These sectors will get ‘what’s fair’ i.e. they keep their current real income (at least)

        I do question this spare capacity idea on a couple of bases? Where exactly is it? What is it? The only ‘spare’ capacity we have is labour and one could argue about how much ACTUAL spare capacity there is there and what the ‘spare’ capacity can be used for. In addition how do you get someone to invest with all the hurdles that are in place?
        The central problem of the spare capacity idea is that our ‘capacity’ has been boosted by debt growth. Our ‘spare’ capacity is indeed just ‘over-capacity’ in ht worng sectors i.e. sectors that don’t produce anything. Your deficit spending MUST go to those sectors if we are not going to crash this thing – but again your circle doesn’t close.

        The reform required is fundamental. Yes we need our capital controls badly but unless you also reform the whole society at the same time the effect will be devastating – well devastating for anyone who doesn’t have government job, who doesn’t work for a corporate monopoly or oligopoly, or some other organised oligopoly – be it union or business.
        Interst rates have to rise so we save if we are to avoid a CAD or government has to run surpluses while the private sector doesNOT go further into debt. I guess some combination of both is required. Either one will have bad consequences for the current economy.

        Re MMT – the central tenet, and only new idea, of MMT is that you can print, run deficits, whatever. (it’s all basically the same thing in a macro sense ) and it either doesn’t affect the CAD or CAD’s don’t matter. Both ideas are fundamentally incorrect especially in an economy like ours. I know you want it transformed but it isn’t!

      • Flawse,

        How do you run a CAD if you do not have capital inflows?

        If our exports are $100M we can buy $100M of imports.

        If we want to buy more than $100M we need capital inflows and to get them we sell assets or IOUs.

        If the ability to sell assets or IOUs is restricted then buying more than you sell is very difficult.

        That is the point of the exercise. Place limits on the ability of the economy to buy more than it sells by selling assets and IOUs.

        Printing a deficit does not change that. The controls on asset sales and IOUs sold off shore remain.

        Yes inflation would result if deficit printing exceed the shrinking of the money supply due to deleveraging AND that is the limiting factor but there is a mountain debt that needs to be paid and if it is repaid that is a lot of deflation that the deficit printing will need to neutralise.

        You say where will the printed money go? Most of it into the big black hole called deleveraging.

        It cannot go into a CAD if the main CAD capital flows are prohibited.

  2. SweeperMEMBER

    “While feasible for countries individually, collectively the world as a whole cannot devalue (exchange rates are relative prices, not absolute prices), and consequently the world economy becomes inundated with liquidity, leading to all sorts of false price signals and economic dislocations”

    That’s just wrong. The world as a whole can devalue. Provided each nominal depreciation is a byproduct of an easy money policy and not a protectionist one.

    In other words, if every country promised to follow the previous SNB policy and expand their balance sheets to defend a peg (which none could simultaneously defend), the end result would be a huge expansion in the global money stock or a devaluation against the global price level.

    When the major economies each left the gold standard in the 30’s the main expansionary effect came via a devaluation of gold v the price level instead of one currency v another. It’s a similar sort of concept.

    • Sweeper

      I think you might be splitting straws. They know everyone can devale and make money worth less against real goods – no problem. We have been doing thast for a long time.
      They are saying that the world cannot all print without doing so and creating all sorts of distortions and incorrect price signals.

      Just the samer the use of the owrd ‘becomes’ here (the world economy becomes inundated with liquidity) beggars the mind. ‘Becomes’ ????????- HAS become!

  3. reusachtigeMEMBER

    Me and my housing investment pals can’t wait for these lower interest rates. We’ve got our banks on speed-dial ready to get in ahead of the rush for more property loans. We don’t want to miss out!

  4. Surely Aussies can fight the global currency wars in a different way? One way would be more effectively taxing the capital that is flooding into the country taking advantage of the rate spreads.

    This could be done through implementation of Tobin like taxes and increasing foreign withholding tax. Foreigners currently only pay 10% withholding tax on any interest earned in Australia… Far less than domestic creditors.

  5. Pre emptive whatif:

    In a surprise move, the RBA is today expected to raise rates 2 bps in a decisive strike to tame potentially dangerous speculation in the Australian property market.

    The RBA advises strong messaging is required to restrain excessive property price rises in Australia, which already has some of the highest housing prices in the world.

    Governor Stevens, ‘Despite verbal warnings to avoid excess the property market has exhibited worrying degrees of speculative activity which, as we have seen elsewhere, can end badly resulting in major difficulties for financial institutions and Governments alike.’

    ‘We remain committed to ensuring all Australians retain access to affordable housing which provides substantial social benefit and underpins the fabric of Australian life.’

    ‘In addition to restraining property price excess, we are confident the rate rise will come as some comfort to savers and the many Australian individuals and businesses who consume imported goods and enjoy holidays overseas.’‘We expect the impact on the AUD to be within the bounds of recent years but below the highs. As a nation we have lived with the phenomenon of a relatively strong currency for several years.’

    Analysts expect AUD0.85.