Working Papers

Has the RBA Given the ‘Green Light’ to ‘Bubble’ Popping?

RBA Governor Glenn Stevens’ speech to CEDA last night has been widely interpreted as giving a ‘green light’ to deficit spending, as if politicians ever needed permission or encouragement from the Reserve Bank to ramp-up spending.  The really significant part of Stevens’ speech went largely unnoticed:

in addition to the many useful steps being planned by regulators, perhaps we could pay more attention to the low-frequency swings in asset prices and leverage (even if that means less attempt to fine-tune short-period swings in the real economy); we could have a more conservative attitude to debt build-up; and we could exhibit a little more scepticism about the trade-off between risks and rewards in rapid financial innovation. This would constitute a useful mindset for us all to take from this episode.

The fudge word here, of course, is ‘more.’ More could simply mean giving greater weight to the implications of developments in asset prices for inflation and the overall economy.  However, it could potentially extend much further, to an attempt by central bankers to actively manage asset prices at the expense, as Stevens suggests, of shorter-run demand management.  As I argue here, the historical precedents for this are far from encouraging.

A more recent example of a central bank conditioning monetary policy on asset prices was the Reserve Bank of New Zealand’s use of the trade-weighted exchange rate as part of a composite operating target between 1996 and 1999, known as the monetary conditions index.  This practice was abandoned, because the well-known volatility of exchange rates and their very loose relationship with economic fundamentals made it a very poor basis for conducting monetary policy.  The weaker the connection between asset prices and economic fundamentals, the stronger the argument against using asset prices as either targets or conditioning variables for monetary policy.

posted on 20 November 2008 by skirchner in Economics, Financial Markets

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perhaps we could pay more attention to the low-frequency swings in asset prices and leverage

Lets hope so.

Perhaps next time the RBA sees the Debt-to-GDP ratio blow past 165% they might do something about it!

Seriously, did you honestly believe that ploughing that amount of debt into unproductive assets would not have dire consequences?

Oh, and the Battellino speech looks plain silly just weeks later.  “RBA Deputy Governor Ric Battellino tells the public what Steve Keen won’t” indeed.  I think its high time you apologised to Steve Keen.

Posted by .(JavaScript must be enabled to view this email address)  on  11/20  at  01:40 PM

I’m pretty sure that’s the only time I have ever mentioned Steve Keen on this blog, so I’m not sure what I’m meant to be apologising for.

Posted by skirchner  on  11/20  at  03:17 PM

I think few would disagree that targetting the CPI is too narrow.  (Though ironically, the RBA uses even narrower measures of consumer price inflation).  But you are also right to suggest that including asset price inflation has its own problems.

Why not abandon the whole exercise and allow the market to determine interest rates? The quid pro quo being: no govt bailouts.

Posted by .(JavaScript must be enabled to view this email address)  on  11/20  at  06:03 PM

I left this comment at Bolt’s blog this morning.
“I was at that speech. Glenn Stevens spoke very well. The points about fiscal policy were that if there was a good project last year it is still a good project today, and if there was a bad project last year it is still a bad project and the crisis does not make it a good project. He declined to say what ‘good’ and ‘bad’ might be. But consider what Ken Henry said last year in his leaked speech to Treasury. Henry spoke of the 3Ps, population, productivity and participation. The Rudd government has already thrown away more than $10 billion on spending that does not meet the 3P criteria - so that would have been bad spending last year, and by Stevens’ logic would remain bad spending this year.
The argument about ‘moderate borrowings’ translates into the RBA thinking there will be a deficit. If the deficit arose from productive spending it could be justified (I suppose) but the Rudd government is simply throwing money away, so that deficit, if it arises, will arise to fund consumption and not investment.”

Posted by .(JavaScript must be enabled to view this email address)  on  11/20  at  06:06 PM

I’m guessing that the only thing that qualifies as a ‘good’ project is a tax cut, preferably at the top-end to flatten the tax scales.

Frankly, it doesn’t matter whether its ‘good’ money or ‘bad’ money, $10 billion is a drop in the ocean compared with the massive deleveraging that’s happening at the moment.

Stephen:  Are you saying you don’t consider Steve Keen a fruitloop?

Posted by .(JavaScript must be enabled to view this email address)  on  11/20  at  06:43 PM

No. Good projects are those that return more than the cost of capital. As Stevens said last night there are lots of projects like that in Australia and will be for a long time.

I am not at all convinced that government would be able to find too many projects like that. That is why government should focus on those aspects of civil society that are worth undertaking but are difficult to measure, like law and order, rule of law, judiciary and national security.

Posted by .(JavaScript must be enabled to view this email address)  on  11/20  at  07:15 PM

I suspect Stevens would agree with you Sinc but:

Mr Stevens declined to say more, claiming it would “get him into trouble”.

The RBA and government tacitly collude on not criticising each other.

Posted by skirchner  on  11/20  at  08:14 PM

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