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Reserve Bank: they didn't see it coming « Previous | |Next »
November 19, 2008

The doubts about the Reserve Bank continue to grow as more information comes to light. Only this month is it recognizing the decline in household wealth from falling house prices and the decline in retail sales. In October it still saw inflation as the top problem, even as Lehman Bros collapsed, commodity prices collapsed, the share market tanked, and the Australian dollar fell. They reckoned that, because Australia was uniquely placed by the resources boom, it could avoid a substantial downturn in economic growth.

Rick Battellino, the deputy governor, was still against interest rate cuts because of the inflationary pressures and he argued that:

household finances and the economy more generally remain in good shape. The main problem that had built up – inflation – is manageable and is being dealt with. The next couple of years will be noticeably more subdued than the past five. We should not be surprised by this as the income and wealth generated over the past five years were simply extraordinary. By definition, the economy must grow at a below-average pace for some of the time. These periods provide the economy with the breathing space to sustain the expansion. There is no reason to assume that the next year or two will not do the same.

That would indicate that it had little understanding of the depth of the financial crisis and the way that its impact of the global economy would effect Australia from the slow down in growth in China and Japan. Or that optimism ruled, as it did amongst most economic commentators.

It's a different story now---the illusion has cracked. It's a turn around in a couple of weeks. The headlines are now about GM Holden halving car production at its Elizabeth plant in Adelaide and a global economic recession. Australia stands on the cusp of a recession, and it is unlikely that interest rate cuts, the fiscal stimulus, and the lower dollar will stop the slide in the short term. Unlike the US there is still trust and confidence in the ability of the policy makers to do the right thing.

Deficit spending will be needed since things are getting worse rather than better in the housing market----as Nouriel Roubini observes:

And of course there is this vicious circle that’s been discussed between the financial shock leading among other reasons to the economic contraction, and now the economic contraction occurring, then the financial losses, the credit losses, delinquencies for households and corporates rising making the financial strains even more severe.

It's called a downward spiral and that means that the Reserve Bank of Australia's ability to pump up the economy by cutting interest rates — has lost traction.

I wonder if the Reserve Bank has any estimate of the bottom of the fall in housing prices? How many people are underwater? What sort of economic stimulus will stop the downward spiral? What would be its size? Does it recognize that 2008 is different from 1992 in that in 1992 Australian consumers were not highly leveraged – it was the companies that were in trouble. This time Australian consumers are among the most highly leveraged in the world, and so Australians are over-extended on two fronts.

| Posted by Gary Sauer-Thompson at 6:41 AM | | Comments (2)
Comments

Comments

Gary,

You are asking questions to which nobody has good answers. It is wet finger in the air time - which is evidently how the size of the $10 billion stimulus payment was arrived at: inject 10% of annual GDP before Christmas, bound to do something significant.

The rational market price for housing is that at which, if you rent the property out, you are making a return of maybe 5% above inflation, and rational rental prices are those that occur rental demand and supply are roughly in equilibrium.

Property prices have drastically overshot on the way up and are likely to undershoot on the way down.

Being underwater is a different issue here from in the US, as mortgage-holders are liable for the outstanding balance regardless of underlying property price. This is not generally the case in the US, where most housing loans are non-recourse and people can simply walk away, leaving a property vacant.

Additionally, Australia does not have the glut of unsold new homes that exists in parts of the US. I wouldn't expect to see anything at all here like the current situation in Southern California, where prices are down 40% from peak and last month 51% of homes sold had been foreclosed.

http://www.latimes.com/business/la-fi-homes19-2008nov19,1,2773132.story

It is true that this situation is unusual in that consumers are over-borrowed. A recent paper by Cynamon and Fazzari, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1153180 analyses reasons why consumers owe so much.

From 1981 to 2005 US consumer expenditure rose from under 90% of disposable income to around 100%, a figure that had never been reached even as far back as 1960. A similar phenomenon has occurred here.

MIkeM,
thanks. I didn't get much from the abstract of the pqper. What I am surprised about is the little exploration of consumer indebtedness in the press. It's almost as if doesn't exist.