It feels like the Chief Economist of Westpac, Bill Evans, has been reading my mind. In this Business Spectator article Evans explains the recent shift in the RBA’s approach to monetary policy to try to more explicitly address concomitant credit and asset price cycles (something I have covered ad nauseam here for several years now). He also provides a kind plug for our house price index data.
Following my last post on this subject, the key point for readers is that Evans’s commentary once again highlights the growing confusion amongst economists and the market more generally as to precisely what is motivating changes to the RBA’s cash rate (as we anticipated). Put differently, it is no longer just inflation, which makes the decision-making matrix a helluva lot more complex.
This “multiple objective” uncertainty has two possibly adverse impacts: it plays havoc with market expectations while also potentially undermining the RBA’s own analytical clarity by diverting it away from its core inflation-targeting regime, which is an arduous enough aspiration in and of itself. As some politicians have recently observed, it is also a contentious issue as to whether this change is consistent with the spirit of the RBA’s pre-agreed mandate with government. Here I would simply say that one should not take liberties with democracy.
On this note, one of my economist friends, who is a central bank sympathiser, argues that the 1959 Reserve Bank Act encompasses a third objective that gives the RBA the ability to effectively do whatever it deems appropriate. More specifically, the Act says that the RBA’s Board (note Board, not executive), can use its powers to best contribute to “the economic prosperity and welfare of the people of Australia.”
My pal went on to claim that perhaps this means the RBA can indeed alter the conduct of monetary policy to account for asset and credit cycles. Maybe they can. Others might contend that Caesar was similarly inclined. If it is not obvious already, I have a problem with this logic. Taken literally, as I know both this individual and some RBA execs like to do, the legislation is being inferred to mean that the RBA actually do whatever it wants so long as, in its unilateral judgment, it contributes to our “prosperity and welfare”. Blind freddy can see that this extraordinarily vague language could, therefore, be used to justify any extreme action, which is patently not consistent with the spirit or understanding of the RBA’s responsibilities.
A further problem for proponents of this view is that the 1959 Act has been supplemented by a new agreement struck between the RBA and the Treasurer for the first time in 1996. It is called the “Statement on the Conduct of Monetary Policy”. The Statement was formulated to remove any remaining doubt as to the RBA’s multiple-objective mandate, which included maintaining full employment. The issue for RBA insiders was that its full employment aspirations could be read to conflict with the more important inflation objectives. To eliminate any residual confusion, the Statement makes the RBA’s absolute focus on inflation-targeting once and for all unambiguous (ie, all other aims are subordinated):
“Since the early 1990s, inflation targeting has formed the basis of Australia’s monetary policy framework. Since 1996, this framework has been formalised in a Statement on the Conduct of Monetary Policy…
Price stability is a crucial precondition for sustained growth in economic activity and employment.”
The Statement itself is regarded as controversial by none other than the most significant Governor of the last 20 years, Bernie Fraser, who also served as Treasury Secretary and was responsible for securing the RBA’s much-needed independence from an otherwise marauding Treasurer and Prime Minister (PK was able to alter interest decisions as late as 1994 according to Fraser and Ted Evans).
Bernie has gone on the record to remark that he had two problems with the Statement: first, it deliberately subjugated the maintenance of full employment objective, which previously sat on a level-pegging with price stability, and, as Bernie has observed, was a win for the inflation hawks inside the RBA who felt that, ironically, having two possibly conflicting objectives undermined the external credibility of the Bank (Bernie was of the view that the employment objective was a powerful rider against an obsessive concentration on price stability to the detriment of growth).
It is a sad indictment on the quality of our public debate that virtually nobody (Stephen Kirchner, Guy Debelle, David Gruen and present company excluded) has come out and said, Hey, wait a second, is not the notion of managing asset and credit cycles a bit contradictory? It once again creates a second, and undeniably conflicting, objective with the RBA's central inflation target, which is exactly what the Statement sought to avoid! This seems currently beyond our otherwise compliant commentariat.
As I have said before, I am actually supportive of many of the RBA’s sentiments apropos the risks associated with asset price and credit cycles. I have over time bought into the argument that careful jawboning and open mouth operations (emphasis deliberately added!) can be helpful disciplining influences on market psychology. All credit to the RBA folks for convincing me of this, which is, I guess, pretty obvious with the benefit of hindsight. And I don’t even mind a bit signalling at the margin via the cash rate, which is what I suspect the RBA will do at the next Board meeting.
But stealthily resolving that this is within the RBA’s remit without formal consultation with the Treasurer and parliament is, I believe, unwise. Glenn Stevens had made tremendous strides towards greater transparency and accountability during his tenure. His parliamentary performances have been very impressive in this regard. For more on this, I would encourage you to have a read of David Uren’s article in The Australian, which highlights the recent role of Vanessa Crowe, whom I have also found to be a very competent operator. Notwithstanding this progress, the RBA executive needs to aim much higher, and formally enfranchise their political masters in their evolving world view. This is, incidentally, what the young parliamentary Turk, Jamie Briggs, had intimated to in his recent grilling of the Governor.
Turning back to Bill Evans, the Westpac warrior had these thoughts to share with us via Business Spectator:
“Our expectation that rates will be on an extended hold is partly predicated on the view that Australia is not entering a period of speculative excess in the housing market. We expect that the recent increases in interest rates and the likely future extra 50 basis points of tightening will lead to an orderly slowdown in the pace of house price increases settling any concerns of a speculative boom.
The essential characteristics of a speculative boom is a sharp increase in leverage; aggressive competition amongst lenders; a relaxation of lending standards; dominance of investors; spruiking of excessively optimistic investment opportunities; and new types of mortgage products being introduced.
Banks are currently focussed on possible limits on lending as regulations and sharp increases in funding costs force them to balance growth on both sides of the balance sheet. These are not the preconditions for a speculative boom. The sharp increase in house prices in 2009 can be explained by shortages; population growth; improved affordability and not excessive leverage. With fundamentals driving prices, a new stable equilibrium can be attained without the likelihood of a massive speculative overshoot.
The RBA's preferred data analysts' for house prices, RP Data-Rismark, noted in a report on 31/3 supports this view that Australia is a long way from an overvalued housing market.
Over the last 12 months Australian capital city home values have increased by 12.7 per cent after values fell by 2-3 per cent in 2008.
Over the five years to December 2009 Australian capital city values increased by 6.2 per cent per annum compared to per capita disposable income increases of 6 per cent per annum.
In Sydney, dwelling values rose by only 1.3 per cent per annum while per capita disposable incomes grew by 5.7 per cent per annum.”
