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Reserve Bank: financial stability and high growth « Previous | |Next »
November 20, 2008

In his speech to the CEDA annual dinner Glenn Stevens, the governor of the Reserve Bank, is pretty optimistic. Even though we face difficult circumstances there is no need to worry really. The economic authorities and regulators have things are in hand by the economic authorities and regulators. All we need to really worry about is worrying about how bad things are. Confidence is what is needed, not gloomy talk.

After reading the speech I had the impression that we live in parallel universes. What has happened in the financial world has been catastrophic and its effects on the Australian economy are likely to cause is a recession and a rise in unemployment. Yet Stevens, whilst acknowledging systemic collapse, continues to think in terms of normal business cycles and the markets automatic stabilisers. Referring to the financial crisis Stevens says that:

a good deal has been done already towards addressing the financial problems themselves. These measures cannot avert a significant slowing in the global economy – it is fairly clear that a recession in the major country group, the G7, is under way. That, in turn, means that credit losses will be incurred by the lenders in those countries as typically happens in a business cycle downturn. But the measures averted, in my judgment, potential systemic collapses that would have had massive repercussions throughout the world. That leaves an international business cycle event to be addressed. So what are the ingredients for doing that?

The worst is over, in other words. Now it's just a matter of a business cycle to sort out. And its easily done. Stevens says that the fall in commodity prices has increased the scope for many central banks to reduce interest rates and for fiscal expansion that passes the ‘good policy’ test. Stevens does not mention an active labour policy (training,wage subsidies, direct job creation), nor say what the good policy test is, other than "worthwhile public investment."

"Worthwhile" is not unpacked. Presumably, it means nation-building infrastructure projects as opposed to tax cuts for the rich, bailing out NSW, or concreting river beds in the Murray-Darling Basin. Does "worthwhile" exclude the recent grants to local government? If not, then what sort of nation-building infrastructure project? Does it include an active labour market policy for unemployed workers?

Stevens adds that it is not realistic to assume that regulators and central bankers will always have the wisdom and prescience, or even the scope, to deploy their few instruments such as to ensure that an ideal combination of financial stability and high growth can be achieved consistently. Note the "ideal combination of financial stability and high growth". There is no mention of policy reform to shift the Australian economy to a low carbon one. Shouldn't a principal policy intervention be to place a price on carbon to support changes on both the consumption and production sides and to encourage necessary investment in R&D and the takeup by business?

On Stevens account, as it stands, we can have high growth coupled with environmental destruction on a massive scale. He qualifies this by saying that policy-makers and regulators both here and abroad will need to stand ready to act promptly to provide any necessary support for the financial system and sustainable economic activity, without saying what sustainable economic growth is. It is not obvious that "sustainable" would include seeking a lower level of emissions or active labour market measures.

Stevens goes on to celebrate the market in terms of the recent shift to greater regulation:

the genius of the market economic system is that so much of the risk that is prudently taken, much of the time, turns out to reward the risk-taker, and indeed all of us, with the profitable deployment of capital, jobs, more choice, higher productivity and better living standards
But he does not mention that greenhouse gas emissions are a classic example of an external cost that is a result of market failure. Both the producers and the consumers ignore any costs caused by the greenhouse gas emissions as they add to the stock of greenhouse gases.

Stevens concludes his speech thus:

given the underlying strengths of the economy, about the biggest mistake we could make would be to talk ourselves into unnecessary economic weakness. Yes, the situation is serious. But, as I suspect CEDA members know well, the long-run prospects for the Australian economy have not deteriorated to the extent that might be suggested by the extent of some of the gloomy talk that is around. If businesses remain focused on the long-term opportunities; if markets and commentators do the same; if banks remain willing to lend on reasonable terms for good proposals; if governments are able to so order their affairs as to continue supporting worthwhile – and I emphasise worthwhile – public investment (even if that involves some prudent borrowing); then Australia will come through the present period.

The biggest mistake is not tackling climate change in a resolute way. It is talking ourselves into unnecessary economic weakness! My opinion of the Reserve Bank sinks lower after reading that "soothing upbeat" speech.

| Posted by Gary Sauer-Thompson at 5:43 AM | | Comments (10)


the interpretation in the mainstream press is that the Reserve Bank has given the green light to take the budget into deficit to foster demand and protect the Australian economy from the deepening financial downturn.

Such a contrast to the 25 years of neo-liberal economics when budget deficits were seen as evil, government debt was bad, and budgets were seen in terms of profit or loss accounts or household budgets. You could only spend money from the surplus have stacking heaps away for a rainy day. If there was no surplus then it had to be slash and burn with a razor gang.

Anything else was held to be economic irresponsibility. That was the level of the political economic debate in this country. Those who questioned it in the name of politics were deemed to be irrational and did not understand the rationality of economics. It was pidgin economics.

"The worst is over, in other words. Now it's just a matter of a business cycle to sort out."

The "worst" that Stevens is referring to, although in cautious, central banker-speak, was the total paralysis of interbank markets following collapse of Lehman Brothers. As Stevens expressed it:

"What had been for over a year a serious dislocation in international financial markets, but one which seemed to be being managed, turned quite suddenly into a very serious crisis during the weeks following the failure of Lehman Brothers on 15 September. In a breathtaking turn of events, the financial landscape changed dramatically, with the failure or rescue and effective nationalisation of a number of systemically important financial institutions in the United States, the United Kingdom and continental Europe."

His full speech is at

While many bank shareholders have lost money, there has been no wholesale run on banks by depositors as there was during the Great Depression and those that have failed have, after the rather clumsy case of Northern Rock, been handled fairly gracefully.

The credit default swaps market is still something of an elephant in the room, but early indications are that it is less explosive than feared.

The Financial Times reported on 6 November that the auction of credit default swap claims relating to the failed Iceland banks completed without drama.

Re Peter's comment, The Australian Financial Review, which is more economically literate than most mainstream newspapers editorialised today that Stevens's address represented "Worthwhile words on debt".

I think there is a general understanding among political leaders as to the meaning of "worthwhile" investment.

Anyone who doesn't know could try asking Ken Henry. In the speech that is said to have lost him his performance bonus last year, he said:

"... divisions will be under pressure to respond to the growing number of policy proposals leading up to the calling of an election and once the election is called. At this time, there is a greater than usual risk of the development of policy proposals that are, frankly, bad.

"More so than at other times, we need to be mindful of the high opportunity cost of proposed policy actions, to advocate sound and wellbeing-enhancing policy action — capacity building measures, better functioning markets, less system complexity and greater fiscal discipline — and to educate others on the full implications of policy interventions in the current economic circumstances."

It is not the role of the Reserve Bank to lay out financial parameters of greenhouse gas mitigation. That is being done by Federal Treasury,

I see that the Federal Government continues to be determined to avoid using "recession" and "deficit" in relation to the Australian economy. Rather strange isn't it, given the green light from the Reserve Bank.

I saw a newsclip where Malcolm Turnbull said that a "competent government" should be able to avoid a deficit. Crazy stuff.

Michelle Grattan in this article says that deficit" is treated as a dirty word.

re your comments:

I think there is a general understanding among political leaders as to the meaning of "worthwhile" investment.Anyone who doesn't know could try asking Ken Henry

Sure. But, judging from media reports, the emphasis has ben on infrastructure for the mining companies rather than public transport.

re your comment:

it is not the role of the Reserve Bank to lay out financial parameters of greenhouse gas mitigation. That is being done by Federal Treasury

Agreed. But shifting to a lower carbon economy should be a policy goal that is given equal weight to financial stability and high growth given Rudd govt policy to bring in an emissions trading scheme.

Shouldn't economic reform be part of the brief of the Reserve Bank as well as financial stability and high growth? The focus seems to be on weathering the storm and shielding the economy in the short term.

It is now a crisis of confidence.So long as the money continues to flow,there is no reason why there should be a total collapse.The US economy is still spiralling backwards with unemployment reaching record levels.
What the US needs is a fully Govt owned Reserve Bank and they can finance their own recovery and not be in debt to the privately owned Federal Reserve.
Some say we need to spend our way out of this diliemma,but that should not include more debt.We had a $600 billion deficit,very similar to the US.This has just gone up with the depreciation of our dollar.
We have to develop our own industries to service our own needs and that will take years.

spending the surplus on worthwhile projects is classic counter-cyclical economics, but it is not economic reform in any shape or form.

re your comment "protect the Australian economy from the deepening financial downturn".The mining industry, seen as Australia's savior by all and sundry due to China's ever continuing economic growth, has been hit by falling commodity prices, rising costs and an inability to raise funds.

They didn't see the downturn in their industry coming; nor the possibility that they would have to scale back production.