Why the RBA is wrong, wrong, wrong

Tue, 14 Nov 2017  |  

This article first appeared on the Yahoo 7 Finance website at this link: https://au.finance.yahoo.com/news/2024247-032933611.html 


Why the RBA is wrong, wrong, wrong

The latest Statement on Monetary Policy has confirmed the failure of the Reserve Bank of Australia to implement monetary policy settings that are consistent with its inflation target and objective of full employment.

It used to be the case that the RBA could never have a medium term forecast for inflation other than 2.5 per cent – the middle of its target range. The thinking was that if the RBA had a forecast an inflation rate of say, 1.5 or 3.5 per cent, that was based on current policy settings, it would adjust interest rates to ensure inflation would not reach those levels, and instead would return to the middle of the target.

The middle of the target range is an important goal for policy because it means the risks to the forecast are symmetrical. A forecast of, say 2 per cent, means that a 0.5 percentage point error could see inflation fall to a troublesome 1.5 per cent as much as it could rise to a perfectly acceptable 2.5 per cent, while a forecast of 2.5 per cent that turns out to be wrong by 0.5 per cent would still mean the RBA meets its target.

And even if the 2.5 per cent forecast turns out to be wrong as economic events unfold in ways not fully anticipated, it would adjust policy again to keep the focus on the 2.5 per cent. The RBA did this well until the global crisis came along and changed the growth, wage, inflation dynamics.

Which is where the recent RBA policy settings have been so wrong.

It has been well over a year since the last interest rate cut.

Recent data and the RBA’s own forecasts show that it will not have inflation within its target range for a total of at least four years.

The forecasts simultaneously show that the unemployment rate will be at 5.25 per cent in 2019, which is a considerable distance from full employment. Those 750,000 unemployed Australians should be affronted by the unwillingness of the RBA to have policy settings that will inflate the economy and increase the chances of 100,000 or more of them getting a job in a stronger economy.

The steadfast unwillingness of the RBA to cut interest rates further is based, it appears, on a fear that such action would create financial instability. In isolation, there may be a shred of substance in this idea given that lower interest rates in isolation might lead to a further ratcheting up of household debt and asset prices.

Yet recent bank profit results show financial stress easing, not rising, with bad debt levels remaining at historical lows and households are on average well ahead in their mortgage repayments.

To the extent that a continuation of the housing boom might present a risk to financial stability, it is vital to note the other failure of the RBA, to embrace and advocate other policy action, rather than unnecessarily high interest rates, to reduce this risk. The RBAs initial reluctance to advocate and then its facile attempt to encourage the financial regulators implement tighter lending standards on banks is a further example of its “strictly ballroom” approach to managing the economy.

Instructing the banks to limit dwelling investor credit growth to 10 per cent and now complaining that 6 and 7 per cent growth is still too high would be laughable if it wasn’t so serious. It illustrates the RBA’s acute misunderstanding of how to use policy settings to achieve important objectives even if those policies are a little unconventional.

Telling the banks to limit housing investor credit growth to, say zero to 3 per cent, would certainly curtail housing demand, reduce financial instability risks and allow the RBA to cut interest rates to improve the cash flow of debtors. It would also encourage much needed business investment, especially in the non-mining sectors.

Housing would weaken but the rest of the economy could growth, invest and employ.

Lower interest rates might also trim some demand for the Australian dollar, which would be another way of providing a little extra stimulus to the economy and employment. Instead, the RBA statements include dozens of comments to the effect that a lower dollar would be helpful for the economy, or that a high dollar is a threat to growth, whilst it does absolutely nothing to influence the dollar’s value.

The thinking of the RBA is stale.

It appears the policy failure is due to its inability to acknowledge and keep up with the dramatic changes in the global and domestic economy that have structurally lowered both the inflation rate and the speed at which the wages can grow.

The proof of the RBAs old-fashioned thinking is evident in the actions of its counterparts in the wake of the global crisis.
Prior to the crisis, who would have imagined for example, negative interest rates would be part of a central bank’s policy armory? Of that quantitative easing would be implemented by the central banks overseeing the economies that make up close to two-thirds of global GDP?

It was not fathomable.

But with dynamic policy makers such as the US Federal Reserve’s Ben Bernanke and Janet Yellen, the European Central Bank’s Mario Draghi and Japan’s Prime Minister Shinzo Abe, have implemented what used to be called unconventional policies. These economies are now seeing above trend growth and sharply lower unemployment which almost certainly would not have happened if interest rates were higher and QE avoided.

In the last few years, had the RBA set monetary policy that was consistent with a medium term inflation forecast of 2.5 per cent, the official cash rate would be about 1.0 per cent, perhaps a touch lower. This, in concert with a tightening in mortgage lending rules to address the housing concern, would have seen the unemployment rate forecast drop to around 4.5 to 4.75 per cent and wages and corporate profits would be higher that they are today.

It is a pity that the RBA has not taken a more pro-growth stance with its policy settings or been more forceful in advocating tighter regulatory standards on part of bank lending for housing. A pity that is for some of the 710,000 people currently unemployed and the further 1.1 million who have a job but would like to work more hours but are constrained form getting those extra hours because the economy just isn’t growing fast enough.

So come on RBA, get your head out of the clouds and textbooks, embrace the middle of the 2 to 3 per cent inflation target that used to serve Australia so well and cut interest rates so that employment and inflation can rise the next time the forecasts are updated.

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Why Australians have lost $300 Billion this year

Mon, 22 Oct 2018

This article first appeared on the Yahoo 7 website at this link: https://au.finance.yahoo.com/news/3665708-004156966.html 


Why Australians have lost $300 Billion this year

The total wealth of Australians has dropped by close to $300 billion since the start of 2018.

How much of that is yours?

The fall in house prices and now the slump in the stock market is undermining the wealth of Australian householders.

This is an important trend given the solid link between the change in wealth and household spending. Numerous studies show that when wealth increases, growth in household spending is faster than it would otherwise be. It appears that householders view their extra wealth in a manner that sees them lower their other savings or use that wealth as collateral for additional borrowing fund extra consumption. They may even ‘cash in’ their extra wealth and use those gains to fund additional spending.

When they observe falling wealth, experience weak wages growth and realise their savings rates are perilously low, they will adjust their spending – down.

Labor almost home, not quite hosed

Mon, 22 Oct 2018

The extraordinary vote in the Wentworth by election, with the 18 or 19 per cent swing against the Liberal Party, presents further evidence that the Morrison government is set to lose the next general election.

There is nothing particularly new in this with the major nation-wide polls showing the Liberal Party a hefty 6 to 10 points behind Labor.

The election is unlikely to be held before May 2019, which is a long 7 months away. A lot can happen in that time but for the Liberal Party to get competitive, but for this to happen there needs to be a run of extraordinary developments.

In the aftermath of the Wentworth by election, the betting markets saw Labor’s odds shorten.

While the odds vary from betting agency to betting agency, the best available odds at the time of writing was $1.25 for Labor and $4.00 for the Coalition.

If, as most now seem to suggest, Labor is ‘across the line’, $1.25 is a great 25 per cent, tax free return for 7 months ‘investment’. Yet, punters are not quite so sure and seem to be holding off the big bets just in case something out of the ordinary happens.

While some segments of the economy look quite good, at least on face value – note the unemployment rate and GDP – others that probably matter more to voters – husong, share prices, wages and other high-frewquency cost of living issues are all looking rather parlous. And none of these are likely to change soon.

There is an old saying for punters – odds on, look on. But $1.25 for Labor seem great value.