In the RBA-commissioned history of the Bank, Selwyn Cornish makes it categorical that rates were not used to dampen house price appreciation in 2003. To quote, "Rather than using interest rates as the policy instrument to dampen activity in the property market, public speeches by Bank officials were used to highlight the risks." As we shall see shortly, the Governor at the time, Ian Macfarlane, was equally opposed to employing rates to assault asset prices in part because he did not believe the RBA had a mandate to do so , and, even if it did, the policy was unlikely to be successful.
I was not previously aware of this, but in a September 2002 speech Macfarlane commented, "Monetary policy has to be directed towards how the average of the whole economy is evolving, not to what a particular sector [ie, housing] is doing...Although we should not allow our perceptions of developments in the housing sector to determine our stance on monetary policy, in our view that does not mean we should remain silent on the subject, and we have not."
In December 2003, Governor Macfarlane further confirmed that the RBA did not use rates in response to house prices, arguing that, "Signs of overheating in the housing market were clearly evident through the second half of 2002 and all through 2003, yet the Bank did not change monetary policy. It was only when it became clear that good economic growth had rerturned both globally and domestically that rates were raised."
A final germane anecdote was the June 2003 opinion expressed by Governor Macfarlane in parliamentary testimony, when he claimed, "There is a view that has gained currency that the only way the housing market will slow down would be if interest rates go up. I do not believe that."
Governor Macfarlane did not think the RBA had a mandate to lean against asset prices
In his final Boyer Lecture, Macfarlane makes the case that using interest rates against asset prices is a very questionable idea (consistent with his decisions in 2002-03), and that the RBA does not have a mandate to do so in any event.
This is fascinating for me personally, as I initially argued the first point, but relented upon persuasion from the Bank. I did, however, persist with the second in the face of opposition from the Bank, which felt that these actions could be regarded as consistent within their 1959 powers.
I called for them to explicitly modify the Statement, which they eventually did, incorporating a new "Financial Stability" section with the crucial words, "Without compromising the price stability objective, the Reserve Bank seeks to use its powers where appropriate to promote the stability of the Australian financial system."
Yet in his 2006 manifesto, former Governor Macfarlane very clearly sympathised with the Greenspan perspective on the rates-asset price puzzle. Here is what he said:
"Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it, for two reasons.
First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, for example, house prices, the whole economy is affected. If confidence is especially high in the booming sector, it may at first not be much affected by the higher interest rates, but the rest of the economy may be.
Second, there is a bigger issue which concerns the mandate that central banks have been given. There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence of inflation, but nowhere to my knowledge have they been delegated the task of preventing large rises in asset prices which many people would view as rises in the keeping of his wealth. Thus if they were to take on this additional role, they would face a formidable task in convincing the public of the need.
Even if the central bank was confident that a destabilising bubble was forming and that its bursting would be extremely damaging, the community would not necessarily know that this was in prospect, and could not know until the whole episode had been allowed to play itself out. If the central bank went ahead and raised interests rates, it would be accused of risking a recession, to avoid something that it was worried about, but the community was not.
If in the most favourable case, the central bank raised interest rates by a modest amount, and prevented the bubble from expanding to a dangerous level, and it did so at a relatively small cost in terms of income and employment growth foregone, would this be regarded as good monetary policy? Almost certainly not. As the public would see only the short-term cost to output and employment, and probably some undershoot of the inflation target, it would not be aware of the boom and bust in asset prices that had been avoided. In all probability, the episode would be regarded by the public as an error of monetary policy because the counter-factual could never be observed...
Central banks have some credibility and authority which can be used in a public awareness campaign to make people recognise the risks they are taking in plunging into an overheated market. This campaign takes the form of speeches, parliamentary testimony, and research papers, which can then be taken up by the media and spread more widely to the community. At the Reserve Bank, we had some success with this approach during the recent house price boom, as indicated by the statements emanating from the real estate industry at the time.
But this still leaves the central bank with a very limited armoury with which to fight against a potentially dangerous asset price boom. The interest rate, which it does not have a clear mandate to use, and public persuasion, which is of limited effectiveness; how would it cope if it faced an asset price boom of the magnitude of those that occurred in the United States in the 1920s or Japan in the 1980s?
Not very well, I expect, and it would probably be held largely responsible for the distress that accompanied the bubble's eventual bursting."
Governor McFarlane confirmed the RBA did not use rates in response to house prices, arguing that, "Signs of overheating in the housing market were clearly evident through the second half of 2002 and all through 2003, yet the Bank did not change monetary policy. It was only when it became clear that good economic growth had rerturned both globally and domestically that rates were raised."
But sensational new claims were published today by blogger David Llewellyn-Smith, who appears to believe McFarlane was either grossly mistaken or deliberately lying!
Who is right? Joye/McFarlane? Or Llewellyn-Smith?
David Llewellyn-Smith
Back in 2003, when Ian Macfarlane’s RBA had been running overly easing monetary policy for years, he suddenly noticed that he had a housing bubble growing in Sydney.
Macfarlane raised rates just 50bps and jawboned the housing market, popping the bubble in Sydney’s mortgage belt. He has basked under the rubric of a forward-thinking central banker ever since. Though he subsequently let the bubble go national and was fortunate he got a soft-landing as the mining boom took off.
This episode has become some kind of benchmark of good bubble management in RBA folklore (and in truth deserves praise in the broader context). Macfarlane’s apparent success flew in the face of the Greenspan doctrine at the time; that bubbles can’t be diagnosed in advance and are best cleaned up afterwards. It also helped make the career of Phil Lowe, current deputy governor, who at the time had written at the BIS in the nicest possible way that Greenspan was on acid.
Anyway, if this is the conventional RBA definition of a bubble then let’s tick off the boxes:
1. Prices are rising far too quickly relative to incomes; 2. Credit is too, with investors now running at 9% per annum which may be half the 2003 level but is off triple the base and GDP has only grown 50% since; 3. Half of credit is now speculative lending, negatively geared; 4. And, from the AFR over the weekend: “A pick-up in the property spruiking business is a signal things may be getting a little too exuberant,” said Paul Bloxham, HSBC Australia’s chief economist. Bloxo is a barometer of RBA convention and can see that another bubble box has been ticked off.
In short, the current major city Australian housing market is a carbon copy of the acknowledged 2003 bubble (except worse) and something is going to have to be done to take the heat out of it. (Or not, and the RBA can drop the Greenspan acid that the market knows better, along with the gamble that it suffers Greenspan’s historic fate).
There are three options for addressing the bubble monetarily (assuming no fiscal support is coming). The first option is to repeat the Macfarlane 2003 bubble-busting episode: two short, sharp rate hikes accompanied with short and sharp rhetoric directed explicitly at property investors. That would pop the bubble again no doubt, so long as the banks didn’t hold the hikes back, which they might. Even then it probably wouldn’t matter given the dollar will head back to parity and exacerbate the tightening.
But, given we’re just heading off the mining capex cliff with an at best luke warm labour market, a housing market stall will send us into effective recession within six months. I say effective recession because with net exports and immigration powering, it’s pretty hard to register an actual recession in headline GDP.
Still, we’d give it a good shake and with lousy income growth, public austerity, collapsing business investment and rising unemployment, one could not discount the possibility of triggering a major housing bust with all of the feedback loops that that presents. Rates would therefore fall back quickly when housing stalled, to well below where they are now, and the dollar would too (there is a chance the dollar would even “look through” the whole tightening episode and not rise too much).
It’s not without merit but is risky, too risky for the RBA board I reckon, and would a mean a pretty nasty back-flip on its own program of rebalancing to non-mining growth.
A second option is to take Bloxo’s approach and start to raise interest rates at a measured pace from Q1 next year and characterise it as a little “normalisation”. That would perhaps let the steam out of the bubble more slowly and mitigate the chances of a sudden bust as it built confidence even as credit got more expensive.
But it would guarantee a rising dollar, certainly as high as parity and probably further, so it would still quickly stall domestic activity, exacerbate the mining bust, smash nominal growth and the Budget and likely work more effectively to bust the housing market than expected. I still think only two hikes would be needed and we’d quickly find ourselves without growth momentum by mid year and facing recession risks as rebalancing ceased.
The third option is to tighten credit using macroprudential tools. If managed right, it would slow the housing market at the margin and enable the RBA to hold rates where they are, or even cut, as I still think will happen. The dollar would fall as the risk of higher interest rates was priced out of spreads and it would offer hope of a genuine rebalancing with improvements to competitiveness, as well as taking pressure off the mining bust and the Budget.
Generally, I think you would have to say that Joye's predictive record on housing is better than David's. David has had a reasonable stab with getting interest rate calls right. But that's about as far as his crystal ball has been able to see. I think it's clear enough that David is in the business of selling candy to would-be homeowners who are priced out of the market and praying for a price correction. The 2014 version of DLS is a bit more experienced (or battle-scarred): he's now adding disclaimers — "I could be wrong about this" — at the end of some of these candy pieces, just in case prices take another leg up and hordes of angry faithful come bashing at the gates again. "I did warn you that might happen," he'd be able to say to them, this time. Also, he's now locking almost all property-related material over at MB — even where he's done nothing more than lift a document authored by another analyst without adding any commentary of his own. He knows that property-related posts are the most popular content over at MB and he's squeezing hard on the cow's teats.
You can whinge about MB all you like Doc, but the name of that "Houses and Holes" dude who writes over there still sums up our economy reasonably well I'd say.
And no, I don't personally follow MB at all - But 'know' "Houses and Holes" from the blogosphere from before he went to MB.
You can whinge about MB all you like Doc, but the name of that "Houses and Holes" dude who writes over there still sums up our economy reasonably well I'd say.
And no, I don't personally follow MB at all - But 'know' "Houses and Holes" from the blogosphere from before he went to MB.
The thread was about DLS, Herbs. So not a whinge mate — just observations in response to the thread title. I don't disagree with you about the property- and mining-centric nature of the Oz economy. But can we make accurate predictions about what's likely to happen with these 'houses' and 'holes'? It's a witty name but ...
The trouble with the world is that the stupid are cocksure and the intelligent are full of doubt — Bertrand Russell
Governor McFarlane confirmed the RBA did not use rates in response to house prices, arguing that, "Signs of overheating in the housing market were clearly evident through the second half of 2002 and all through 2003, yet the Bank did not change monetary policy. It was only when it became clear that good economic growth had rerturned both globally and domestically that rates were raised."
But sensational new claims were published today by blogger David Llewellyn-Smith, who appears to believe McFarlane was either grossly mistaken or deliberately lying!
Who is right? Joye/McFarlane? Or Llewellyn-Smith?
Quote:
There are three options for addressing the bubble monetarily (assuming no fiscal support is coming). The first option is to repeat the Macfarlane 2003 bubble-busting episode: two short, sharp rate hikes accompanied with short and sharp rhetoric directed explicitly at property investors. That would pop the bubble again no doubt, so long as the banks didn’t hold the hikes back, which they might. Even then it probably wouldn’t matter given the dollar will head back to parity and exacerbate the tightening.
David has not been able to pick the housing market for as long as I can remember. As Doc Watson remarked he has had some success on interest rates, a better record than CJ's - but on the more crucial issue of house prices CJ has been far more correct.
Funny that someone predicting interest rate falls would be predicting house price falls at the same time. That's counterintuitive.
If the RBA adopted David's recommendations they would be stepping in just when the market got a supply response, and if rates were raised at that point it would dampen the market to the cheers of many, but then create an even bigger problem 5 or 10 years later when the undersupply became even more pronounced.
In my view the problem pointed to by David isn't the problem, his cure is the problem, it will create an undersupply even greater than today's. We need the boom bust cycle to provide supply (oversupply perhaps) and then swing to undersupply as the population increases. It will always be like a cat chasing it's tail.
No developer or builder is going to build unwanted homes or apartments, that's an investment that's too big for them to absorb into their cash flow so in a country with a rapidly growing population the undersupply will always be a feature of our housing market. At best we can only get close to a balanced supply or limited oversupply in some areas, and we will never get to that point if the RBA keeps restraining the supply response.
I guess David has his heart in the right spot wanting more affordable homes for the populace, but I don't believe he has read the market well enough to make the right recommendations.
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