Putting the politicians on notice

October 18th, 2009

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Over the weekend, the Reserve Bank of Australia (RBA) governor, Glenn Stevens, surprised the financial markets with his unusually hawkish stand on interest rates. In response, as this news article reported,

Financial markets responded by pricing in the most rapid series of interest rate rises Australia has seen for 15 years. Markets now predict that the Reserve board will raise rates at seven consecutive meetings, lifting its cash rate from 3 per cent 10 days ago to 4.75 per cent by May and 5 per cent by July.

As we wrote back in July (see How are central bankers going to deal with asset bubbles?), under the influence of William White of the Bank for International Settlements (which is dubbed as the central bankers’ central bank), there’s a sea-change in central bankers’ thinking. Glenn Steven’s aggressiveness is the result of such a sea-change. Our long-time readers should not be caught by surprise at this, unlike the financial markets.

Economists like Professor Steve Keen reckons that if the RBA really carry through its threat that way, it will be a big mistake. The problem with monetary policy is that it is an extremely blunt instrument. Though rising interest rates can put a brake onto the growth of dangerous debt-fuelled asset bubbles, it will also constrict other sectors of the productive economy as well. The risk is that the productive sectors of the economy may be crippled, bringing down the rest of the economy along with it, and as a result, burst the existing asset bubbles in a spectacular way.

Therefore, what is needed is a very precise tool that can target asset bubbles specifically while leaving the rest of the economy alone. Unfortunately, the RBA do not have the power to to enact such a precise policy tool- they can only change the interest rates lever. On the other hand, the arm of the government that are controlled by politicians has the power to formulate such a tool. Very unfortunately, we have politicians who are unwilling to attack asset price bubbles (and worse still, inflate the bubble even more), due in part to control of vested interests and fear of losing elections.

The outcome is that we will have politicians (both at the State and Federal level) and the central bank engaging in policies that are uncoordinated and mutually incompatible. Unless that change, there’s a significant risk of loss of control of the economy by the government. Should this happen, the most convenient scapegoat will be Glenn Stevens as he will be accused as the man who bust up the Australian economy. But for us, we will point the finger at the Rudd government because they understood what the root cause of the GFC (see the essay written by Kevin Rudd here) but instead, not only did nothing to deal with Australia’s towering debt levels, but also introduced policies that increase the risk of a home-grown credit crisis in Australia (the most notorious is the FHOG). The State governments are not any better either.

The politicians must be put on notice.

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