As published in Property Observer and Business Spectator...
So it’s now official. All the analysts, commentators, and
policymakers who told you that Australian economic growth was decelerating,
“sub-trend” (a popular phrase), “modest”, “below capacity”, or about to head
into recession were woefully misguided. Anyone who predicted interest rate cuts
over 2011 and 2012 on the basis of a weak domestic economy was right, but for
the wrong reasons.
Indeed, if the “sub-trenders” had any intellectual honesty,
they would be calling for a spate of rate hikes right now. If the (falsely, and
now revised) low real GDP print in the final quarter of 2011 was grounds for
hysterical calls for cuts, the last four quarters of growth data combined with
the many months of jobless rate data are surely an even more persuasive basis
for hikes? One of the smartest strategists in Australia did write to me today,
unsolicited, and state, “I was wrong – economy doing okay…[and] yes, you were
correct.”
Australia’s economic growth rate over the last four quarters
has been a stunningly strong 4.3%, well in excess of estimates of the trend
rate of growth of around 3% per annum. Australia’s jobless rate was just 5.1%
in May, slightly up from a revised 5.0% in April, but down on a three month
moving average basis from 5.2% in March. Since 1990, the jobless rate has
averaged 6.9%.
At the same time, we know that business investment continues
to boom (and businesses plan to invest at record rates for years to come),
household consumption, which is the biggest driver of economic growth, is
expanding at a rate way above historical trend, housing credit growth is
tracking incomes very closely, which is what we would expect, and the total
wages bill rose at an above-trend pace in the first quarter.
Based on the information we have available to us today, the
RBA’s pre-November monetary policy settings—remember they take 12-18 months to
have their full effect—were pitch perfect, as I
argued in the past. It was those settings, and not subsequent cuts, that
gave us a more acceptably low inflation rate.
Those calling for savage rate cuts in the second half of
last year badly misread the economy. The bottom line is, as both Professor
Warwick McKibbin and I have previously argued, if you assume the appreciation
of the Australian dollar was a once-off event, there was no domestic economy
basis for rate cuts as the inflation benefits (in late 2011 and early 2012)
would be temporary.
The RBA board and its staff have a lot of explaining to do
for their post-November decision-making. Glenn Stevens has repeatedly told the
community that the RBA does not believe it can forecast with accuracy over the
long-term. He repeatedly pushed the notion that it needed to focus on
“nowcasting” in justifying its rate cuts in late 2011. When the RBA got a
downward revision to the second quarter inflation data in June 2011 from 0.8%
to 0.6%, it used this data point to materially change the stance of monetary
policy from restrictive to neutral. But it turned out that this core inflation
estimate was wrong: it subsequently got revised back up to an unacceptably high
0.8%.
As any inflation forecaster knows, you do not get a
consistently low inflation rate with real GDP growth of 4.3% per annum, an
unemployment rate of 5.1%, and a currency that is stable or declining.
In the latest inflation numbers, domestic (or so-called
“non-tradeable”) inflation printed at around 3.5%, well above the RBA’s 2-3%
per annum target. Australia’s low inflation pulse in late 2011 and early 2012
was being driven mainly by internationally priced goods and services (or so-called
tradeables), which were actually falling in value as a result of the temporary
currency appreciation.
So something important in the RBA’s decision-making changed
late last year. It stopped nowcasting and started forecasting. It increasingly
ignored the very low unemployment data despite the fact that the unemployment
rate is the single most important variable in its inflation forecasting models.
It has ignored a great deal of “partial” data—business
investment, household consumption spending, wages, domestic demand, and even
the narrowly-measured monthly retail data—and calibrated policy on the basis of
utterly subjective and, it appears, quite incorrect forecasts.
In a tiny cohort of analysts--including Adam Carr--I have
consistently argued that the December, May and June rate cuts were unnecessary
(and received immense push-back for doing so). I’ve maintained that the RBA was
bowing to pressure from a community that has not seen a recession since 1991, a
public that has become incredibly complacent, with many generations having been
exposed to declining interest rates and a falling unemployment rate for most of
their lives. The RBA has been relentlessly bullied by both sides of politics
and their proxies (eg, leading union officials and aligned commentators), and,
we know, the six private sector doves that dominate the RBA’s board (to say
nothing of the Treasury Secretary).
It is clear that the RBA has rejected its own
decision-making logic by setting policy not on hard and dependable economic
data, but rather on the basis of speculation and, most worryingly, financial
market expectations.
The RBA’s inflation forecasts are now all wrong. The pulse
of economic growth is much higher than it has assumed. The unemployment rate is
well below the 5.5% it expected. Even after today’s terrific jobs report, the
Aussie dollar is still materially lower than the 103 US cents it presumed (as
are oil prices).
I coined a term late last year: the “Glenn Stevens put”,
which insinuated that the RBA was doling out insurance to vested interests and
the financial markets when it had no business doing so.
It has punished hard-working Australian savers in preference
for less prudent borrowers. On the basis of today’s data, interest rates in
Australia are probably a good half to three quarters of a percentage point
lower than they need to be.
There are certainly no signs of a household deleveraging
induced recession in the manner predicted by the likes of Steve Keen. Sure,
house prices have endured a modest correction. Yet this has been largely driven
by the luxury sector.
Since January 2011, 80% of all Australian suburbs have
experienced total house price declines of less than 3%. Yet the most expensive
20% of suburbs have suffered house price falls of around 7%.
One of my regular memes has been that we have had a
valuation re-rating in the million dollar-plus market due to the (permanent)
contraction in financial services earnings growth. That’s not a bad thing.
The droves of analysts that called for much lower rates on
the basis of sub-trend economic growth should front up and admit they were
wrong. An inquiry is needed into the RBA board’s decision-making processes,
which appear predisposed to persistent error.
Australia’s average core inflation rate since 2001 has been amongst the
highest of our developed country peers. At a minimum, we need to get rid of the
RBA board’s highly conflicted private business sector executives and replace
them with professionals who understand how the aggregate economy works.
