RBA governor Glenn Stevens delivered a ‘solid’ speech last week. Solid being a favoured, if over-exercised, bromide for central bankers. Stevens made a few interesting remarks, which, if I can say so, echoed points I’ve consistently pushed here.
First, the local media and local economists have not been dispassionate in assessing Australia’s economic circumstances. As I’ve said before, if you predicted a raft of rate cuts late last year on the basis of a weak Australian economy, you were indisputably right for the wrong reasons. Stevens comments:
“Yet the nature of public discussion is unrelentingly gloomy, and this has intensified over the past six months. Even before the recent turn of events in Europe and their effects on global markets, we were grimly determined to see our glass as half empty. Numerous foreign visitors to the Reserve Bank have remarked on the surprising extent of this pessimism. Each time I travel abroad I am struck by the difference between the perceptions held by foreigners about Australia and what I read in the newspapers at home.”
The good news is that Stevens’s speech has had an immediate impact on editorial behaviour and hamstrung the more hysterical gloomers. Most of the major media outlets have jumped aboard, with a notable shift in the tenor of output in the big broadsheets. Let’s see how long that lasts.
The second point, which Stevens would never admit, is that the RBA are worried about the effects of excessively low interest rates on asset prices, and housing in particular. This has been compounded by the fact that the RBA made a policy mis-step in cutting rates too hard between November and now on the basis of flawed survey data, financial market speculation, and subjective forecasts.
In his speech, I was intrigued to see Stevens warning Australians against relying on trend house price growth and defensively arguing that the RBA was not cutting interest rates to bolster asset prices. For mine, this is a subtle tell apropos the RBA’s policymaking mistakes. Suddenly it is worried about unintended consequences:
“You don’t have to be a believer in bubbles to think that a return to sizeable price increases and higher household gearing from still reasonably high current levels would be a risky approach. It would surely be a false basis for confidence. The intended effect of recent policy actions is certainly not to pump up speculative demand for assets.”
This is not exactly right. First, the RBA thinks there has been massive underbuilding in the housing sector and would like to see a big increase in appropriately located and constructed housing supply over the years to come. The central bank has said this repeatedly. Second, the RBA (now) knows – as I warned years ago – that it is not going to get investments of scarce capital in risky housing supply while asset prices are declining.
The most germane thing about asset prices is this. On the one hand, the RBA knows that the Australian banking and mortgage insurance systems have been heavily criticised by institutional investors for their high exposures – 60% on average for the banks – to Australia’s supposedly over-valued housing market. This is unambiguously regarded as Australia’s number-one macroeconomic risk. The RBA spends considerable time and effort meeting privately with global investors trying to convince them otherwise.
The RBA further knows that if house prices were to decline materially, it would imperil the entire financial system. The disaster-delivery-device would, of course, be the banks. Slumping prices would slash the value of collateral on bank balance sheets. This could cause credit rationing that further accentuates the price falls, and so on. Rest assured, the RBA would do everything possible to resist this outcome, and would absolutely use interest rates to support asset prices. This is an integral part of the RBA’s “financial stability” mandate, which it is very focused on.
It is also true that the RBA has been somewhat unnerved by the recent house price action, with, thus far, a failure to see any obviously positive response to the central bank’s anxious cuts.
Now I don’t think there is much chance of this negative asset price/bank credit rationing feedback loop coming to pass. But it is precisely the sort of scenario that gives Glenn Stevens and Phil Lowe heart palpitations.
(As a technical aside, I think it is fascinating to see the RBA referencing Australia’s new “daily” house price index data, noting that while prices stabilised in the first four months of 2012, they started slipping again over mid-April and May.)