Soft landing or crash?
Wednesday, February 6, 2008/
The Reserve Bank has now moved interest rates from 4.25% to 7% in 11 consecutive increases since May 2002 – the most elongated monetary policy tightening cycle in living memory.
During that time the US Federal Reserve has increased rates from 1% to 5.25% and then dramatically cut them over the past five months back to 3%, as a big rise in credit defaults produces a financial market correction and slowdown and probably recession in the US.
Apart from being the longest, slowest period of tightening, this is also the first time the RBA has raised rates into the teeth of a US slowdown and credit squeeze.
The question of whether rates should have gone up yesterday is now irrelevant. But this should be the peak of the cycle and the next move should be down – but that’s not certain either.
The authorities – that is the RBA, Treasury and Federal Cabinet – have apparently woken up with a start to the fact that inflation in Australia is still accelerating despite 10 rate increases in a row and a US credit crisis and slowdown.
As the former NSW auditor general Tony Harris set out in yesterday’s Australian Financial Review, this has apparently been a very sudden realisation by Treasury in just the past few months, between its pre-election mid-year economic and fiscal outlook and the first briefing of the new Government (either that or there was some fibbing going on last year).
The RBA has been worried for a while and has just got rather anxious. The Governor Glenn Stevens stepped up the urgency of the wording in yesterday’s statement with the rate increase, saying that “a significant slowdown in demand from its recent pace is likely to be necessary”.
Domestic demand is growing at around 4%; he probably means it must be halved. If that does not happen as a result of this rate increase, plus a fall in consumer sentiment caused by the problems on financial markets and a recession in the US, then there will be more rate increases.
Who’s to blame for this state of affairs? Well, everybody and nobody.
The failure of demand to moderate in response to 10 consecutive rate increases over eight years is due primarily to two things:
First, a boom in house prices and the sharemarket has encouraged a big increase in debt, much of which has been spent on consumption through flexible home loans connected to ATM cards.
Second, Chinese demand has raised commodity prices and produced a resources boom that has taken the unemployment rate to a 33-year low and produced huge tax revenues for the Government, which the former PM showered upon an ungrateful electorate.
The high level of household debt led the RBA to be cautious about how quickly it raised interest rates, so for eight years the bank has been lifting by 25 basis points, then running back to watch what happens for a while before venturing out to do it again.
The Howard government basked in the resources boom revenues and flung the cash back at the nation’s citizens in the form of tax cuts and middle-class welfare payments, which they have been happily spending – adding to the extra money borrowed on the house.
And this seemed OK for a while, because everyone’s super was booming thanks to the sharemarket.
To quote the old cliché coined by William McChesney Martin, chairman of the Federal Reserve from 1951 to 1970, Glenn Stevens has now decided very definitely to remove the punch bowl from the party, and for the first time he has political support for this.
So one way or another, the Australian economy is going to be crunched this year. Obviously all of those who are focused on bringing it about – the RBA, Treasury, the Prime Minister, the nation’s economists – want and expect a soft landing.
But this is notoriously difficult to achieve, especially when unpredictable things are happening in global markets, when the US is struggling and when the Chinese Government is also trying to slow down its own economy (and will probably succeed after the Olympics).
That’s why monetary policy has become dangerous, in my view.
There are signs that after eight years of caution the new RBA is throwing it to the winds, egged on by a new Government keen to see any inflation fighting concentrated into its first year of Government, while it can still be blamed on the previous bloke.
This story first appeared in BusinessSpectator.com.au