The Daily Telegraph terrorises the RBA

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This blog entry first appeared as a fea­ture in the Dai­ly Tele­graph on Wednes­day April 9th 2008. If you’re a new­com­er to it cour­tesy of that fea­ture, and you want to look at this issue in more depth, there are links below to more detailed analy­sis.

The Dai­ly Tele­graph lived up to its nick­name of “The Dai­ly Ter­ror” last week, with a front­page attack on Reserve Bank of Aus­tralia Gov­er­nor Glenn Stevens enti­tled “Is he Aus­trali­a’s most use­less?”, and an edi­to­r­i­al that was no less provoca­tive: “RBA boss is los­ing inter­est”.

It would be easy to crit­i­cise the Telegraph’s com­ments on the tech­ni­cal­i­ties, many of which they got wrong (I’ll out­line some of those below). But what I saw behind the com­ments was a sense of frus­tra­tion that, I believe, is jus­ti­fied.

Why? Because over a decade ago, our Gov­ern­ment ced­ed con­trol of mon­e­tary pol­i­cy to the RBA, in keep­ing with a world­wide belief that “Cen­tral Bank Inde­pen­dence” would result in bet­ter mon­e­tary pol­i­cy.  We were told that if we took mon­e­tary pol­i­cy out of the hands of the politi­cians, and hand­ed it over to the experts, the finan­cial sys­tem would work a lot bet­ter.

If that’s the case, then some­thing has gone ter­ri­bly wrong. Far from giv­ing us sta­bil­i­ty, the peri­od of Cen­tral Bank Inde­pen­dence has ush­ered in an unprece­dent­ed finan­cial cri­sis, and extreme finan­cial hard­ship for many ordi­nary work­ing fam­i­lies (to use a Kevin­ism).

This is what moti­vat­ed the Telegraph’s ire—especially since Steven­s’s tes­ti­mo­ny appeared to down­play both the seri­ous­ness of the cri­sis, and the dam­age that a dys­func­tion­al finan­cial sys­tem has done, and is doing, to the rest of soci­ety.

Steven­s’s tes­ti­mo­ny empha­sised the RBA’s role in fight­ing infla­tion above all else. But the broad job descrip­tion of Cen­tral Banks is to ensure the sound­ness of the finan­cial sys­tem, and on that Cen­tral Banks world­wide have clear­ly failed.

Think about it. If this pol­i­cy had been suc­cess­ful, then the Dai­ly Telegraph’s spray would­n’t have hap­pened, because finance would have been on the bor­ing back pages of the paper.

So how did Cen­tral Banks get it so wrong?

Large­ly because they fol­lowed accept­ed eco­nom­ic the­o­ry about what their role should be. At the time Cen­tral Banks were allowed to set mon­e­tary pol­i­cy inde­pen­dent­ly of gov­ern­ments, the con­ven­tion­al eco­nom­ic wis­dom was that they should:

  • ignore stock and hous­ing mar­kets;
  • for­get about try­ing to con­trol the mon­ey sup­ply;
  • dereg­u­late the finan­cial sys­tem to make it more effi­cient; and
  • just use short term inter­est rates to con­trol infla­tion.

If their suc­cess is mea­sured sole­ly on the front of con­trol­ling infla­tion, then the RBA has met its tar­get of keep­ing infla­tion in the range of 2–3 per­cent over the medi­um term. The aver­age val­ue from 1996 till now is smack in the mid­dle of this range.

How­ev­er, while the part of the sys­tem that Cen­tral Banks have focused on has done pret­ty well, the rest has gone to hell in a hand­bas­ket.

The finance mar­kets were over­tak­en by alchemists who promised to turn lead into gold—or sub­prime mort­gages into AAA secure bonds. Instead, they deliv­ered lead aplen­ty to bor­row­ers and investors, and abscond­ed with the gold them­selves. Debt reached lev­els that have nev­er occurred before in human his­to­ry. Asset prices reached unsus­tain­able (and for hous­ing, unaf­ford­able) lev­els, and are now crash­ing, and tak­ing peo­ples’ hous­ing and liveli­hoods with them.

It’s worth get­ting a han­dle on just how bad­ly the peri­od of Cen­tral Bank Inde­pen­dence has gone wrong—and not only in Aus­tralia.

The Great Depres­sion began with pri­vate debt lev­els in the USA equal to one and a half times its GDP, and then deflation—falling prices—and falling out­put drove it up to 215 per­cent by 1932. Today, US debt is 280 per­cent of GDP.

Aus­tralia peaked at 77 per­cent of GDP in 1932; we’re already at 165 percent—when the RBA appears to think every­thing is func­tion­ing well. And anoth­er 14 major OECD coun­tries are in the same pick­le (the only major excep­tion is France).

Asset prices are also sim­ply crazy.

The best mea­sure here is to com­pare them with the con­sumer price index, and on that basis US house prices bub­bled from 12 per­cent above the long term trend, to 120 per­cent above it in the first ten years of Greenspan’s inde­pen­dence.

Our hous­ing price bub­ble was even worse than that, and though it has not yet start­ed to deflate as has America’s—where prices have fall­en 16% in real terms in the last two year—ultimately it must.

If politi­cians had been respon­si­ble for a pol­i­cy mess like this, the press would have had their guts for garters—and right­ly so. But since the so-called experts are in con­trol, they can’t be held to account—and hence the Telegraph’s frus­tra­tion, which boiled over last week.

In fact, econ­o­mists aren’t experts about the econ­o­my in the same fash­ion that physi­cists are about nuclear ener­gy. As George Soros argued recent­ly in the Finan­cial Times, the approach Cen­tral Banks have been fol­low­ing has clear­ly failed, and it’s time we gave a new approach a try—one that doesn’t sub­scribe to the myth that the best mar­ket is a dereg­u­lat­ed one.

The errors in the Daily Telegraph’s article

The RBA’s job isn’t to tell banks what to charge on mort­gages. The one rate they have con­trol over is the inter-bank rate, which is used when one bank has to pay inter­est to anoth­er when their accounts don’t bal­ance. That sets the floor for short term rates–and the RBA sup­plies as much liq­uid­i­ty as it needs to make sure this rate applies.

Then banks set their own longer term rate in accor­dance with this base rate and mar­ket con­di­tions. In the recent past, com­pet­i­tive pres­sure from non-bank lenders made the gap between the (short) RBA inter­est rate and (long) mort­gage rates the low­est they’d ever been–but much of that reflects what is now euphemisti­cal­ly called “a mis-pric­ing of risk”.

The dilem­ma for the bank is that the cred­it crunch has caused this once nar­row gap between short term and long term rates to balloon–and there’s lit­er­al­ly noth­ing they can do about it. In one sense, it helps keep banks solvent–since they make mon­ey from the spread between short and long term inter­est rates–but it makes the RBA even less able to influ­ence mort­gage rates.

The Com­mon­wealth Bank also did­n’t increase its rates just because of Steven­s’s speech. They would have done their cal­cu­la­tions about their increased cost of fund­ing cour­tesy of the cred­it crunch, and how much this was cost­ing them, well before the speech. Maybe it did how­ev­er make them think that “now’s the time” to move on it.

The real issue, as I out­line above, is that the era of Cen­tral Bank Inde­pen­dence has­n’t “tak­en finance off the front pages”, but made it front and cen­tre with the biggest finan­cial cri­sis in world his­to­ry.

Further reading

  • This blog. I start­ed it one and a half years ago, when I con­clud­ed that a seri­ous debt-dri­ven finan­cial cri­sis was inevitable, and some­one had to raise the alarm about the pos­si­bil­i­ty of one hap­pen­ing. Here you will find:
    • The Debt­watch Report (21 to date) which come out just before the RBA meets each month to set rates, and takes a top­i­cal look at eco­nom­ics and the rate deci­sion in par­tic­u­lar;
    • Aca­d­e­m­ic papers that focus on the top­ics of debt defla­tion and the mon­e­tary sys­tem;
    • A Pod­cast record­ed after each Debt­Watch report by Stu­art Cameron of Rife Media
  • My report And Deep­er in Debt pub­lished by the Cen­tre for Pol­i­cy Devel­op­ment last Sep­tem­ber.
  • Debunk­ing Eco­nom­ics, a web­site that sup­ports my book of the same name, and stores my lec­tures on eco­nom­ics and finance at the Uni­ver­si­ty of West­ern Syd­ney.
  • Blogs by oth­er com­men­ta­tors whom I believe have a han­dle on what has hap­pened. For a decade or more, these writ­ers have been “con­trar­i­ans”, rail­ing against the stu­pid­i­ty of Wall Street and accom­moda­tive Cen­tral Banks while the rest of the pun­dits applaud­ed such finan­cial inno­va­tions as … sub­prime loans:
  • Lest it be thought that I’m a crit­ic of every­thing the RBA does:
  • Dit­to for the US Fed­er­al Reserve. While I believe that the “Greenspan Put” has encour­aged “moral haz­ard” behav­iour that has made this the worst finan­cial bub­ble ever, the Fed has also been a bas­tion of free and acces­si­ble data. My US data large­ly comes from its Flow of Funds report.
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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.