Real­ity Bites in Australia’s Sav­age Rate Cut

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Yes­ter­day the RBA (Australia’s Cen­tral Bank) cut its reserve rate by three quar­ters of a per­cent, to 5.25 per­cent. This is the third cut in 3 months, bring­ing the cumu­la­tive reduc­tion since Sep­tem­ber to 2 per­cent

This is a far cry from the RBA’s expec­ta­tions in 2007, that in 2008 it would be rais­ing rates to con­strain a boom­ing econ­omy and bring infla­tion back down to its tar­get range.

Infla­tion is still above its tar­get, but clearly that’s a bulls eye the RBA is no longer aim­ing for. What on earth went wrong with the RBA’s pre­dic­tions for 2008?

The RBA’s mis­take was to fol­low con­ven­tional eco­nomic theory—known as “neo­clas­si­cal eco­nom­ics”. This the­ory com­pletely ignores pri­vate debt, in the belief that pri­vate debt reflects ratio­nal deci­sion-mak­ing and will there­fore always be at a “Goldilocks” level—“just right”.

The things that go wrong, accord­ing to this the­ory, are the prod­uct of gov­ern­ment decisions—where the dis­ci­pline of the mar­ket can’t exist. The Reserve was openly crit­i­cal of gov­ern­ment pol­icy in the pre­vi­ous years, which it regarded as too infla­tion­ary. This is why it put inter­est rates up last Novem­ber, dur­ing the Aus­tralian elec­tion campaign—an unprece­dented move.

It’s also why the Rudd Gov­ern­ment made every noise it could about being fis­cally respon­si­ble ear­lier this year, to sig­nal to the RBA that there was no fur­ther need to raise inter­est rates.

The RBA did increase rates twice more of course—in Feb­ru­ary and March of this year. Then just six months later, it changed tack—cutting rates first of all ten­ta­tively, and then deci­sively.

In doing this it is now going directly against the the­ory that once guided it—because that the­ory is clearly wrong. Above all else, it is now obvi­ous that pri­vate debt lev­els aren’t the result of ratio­nal deci­sion-mak­ing, but the prod­uct of an irra­tional exu­ber­ance that asset prices would always increase. 

In other words, it wasn’t “just right Goldilocks” tak­ing out the debt, but Daddy Bear, under the influ­ence of naïve the­o­ries about the econ­omy that were every bit as intox­i­cat­ing as bad beer. Now with falling share prices every­where, and house prices tum­bling almost every­where (even in Aus­tralia on the lat­est Aus­tralian Bureau of Sta­tis­tics fig­ures), the global econ­omy is being dri­ven south by an enor­mous debt hang­over.

The RBA is being forced to fol­low, and it deserves some kudos for so rapidly turn­ing around from admin­is­ter­ing the wrong med­i­cine to at least try­ing to reduce the pain of the hang­over. But there is much fur­ther to go. Each 1 per­cent reduc­tion by the RBA reduces the inter­est pay­ment bur­den on the econ­omy by $18 bil­lion a year—if the cut is passed on. But as the Bear fam­ily goes from irre­spon­si­bly binge­ing on the credit card, to try­ing to live within its means and reduce debt, spend­ing in the econ­omy dives by far more.

In the USA, pri­vate debt rose by US$4.5 tril­lion in 2007. That fig­ure is rapidly spi­ralling down towards zero now, and with it con­sumer spend­ing is collapsing—as Gen­eral Motors con­firmed on Mon­day when it reported a 45 per­cent fall in sales. Sales by all auto man­u­fac­tur­ers were severely down, with sales in Octo­ber being 32 per­cent lower than a year ago.

Aus­tralia is not quite so debt-depen­dent, but even here increased debt accounted for A$260 bil­lion of spend­ing last year, com­pared to our GDP of A$1.08 tril­lion. As we sta­bilise debt, the econ­omy itself will desta­bilise. The RBA, and the Gov­ern­ment, are doing all they can to tip the bal­ance back the other way, but we should never have got into this posi­tion in the first place. A gen­er­a­tion of bankers, and of econ­o­mists, have a lot to answer for.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • GSM

    House prices tipped to fall by 10pc”

    http://www.abc.net.au/news/stories/2008/11/11/2416059.htm?section=australia

    The cat is well out of the bag now.House prices are set to fall sig­nif­i­cantly and should unem­ploy­ment rise to 8–9% + then we could see house prices in freefall as delever­ag­ing get’s a full head of steam here with new home buy­ers sit­ting on their wal­lets too.

    Despite all the good China news, look­ing at resource com­pa­nies slashed projects,consumer con­fi­dence decline, busi­ness con­fi­dence col­lapse, com­mer­cial RE tak­ing major hits,banks bad debts pil­ing up- etc, I do not see Aus­tralia escap­ing what will look and feel like a reces­sion. Pos­si­bly a nasty one ala 1980’s.

  • Bull­turned­bear

    debowen,

    I’m no defender of the RBA but I do not believe that they drive sen­ti­ment, they only fol­low it. Here’s what I mean:

    If peo­ple are overly opti­mistic and bull­ish, they bor­row, expand the money sup­ply and spend spend spend! This causes prices to rise and then rates rise. So who drove the rate rises? The con­sumer, not the RBA. Then once sen­ti­ment turns. Peo­ple worry they have too much debt and they reduce spend­ing, bor­row­ing, etc. The econ­omy starts to slow, so the reserve bank begins to drop rates. Once again who is caus­ing the change? Not the RBA, they sim­ply fol­low the herd who has already stopped spending/started reduc­ing debt!

    If you remove the RBA from the equa­tion and assume inter­est rates do not change. The same process would occur. Some would say that the RBA smooths out the tops and bot­toms, or maybe they make it worse!

  • blueinca

    Ken said: “blueinca, I sug­gest that if you have prob­lems with auc­tions, avoid them and get over it, your con­cerns aren’t rel­e­vant to this blog. Any manip­u­la­tions are only a minor fac­tor in the pric­ing of prop­erty.”

    arrgh duh… you can over-intel­lec­tu­al­ize all you want about debt dri­vers, but at the end of the day, peo­ple pay­ing more for House-Prices than what they are gen­uinely worth is rel­e­vant to the debate. If an auctioneer/vendor is allowed to sim­ply ignore what the mar­ket believes the prop­erty is worth/willing to pay and sim­ply say- ‘well, that isn’t enough- you are sim­ply going to have to bid or nego­ti­ate at above this amount’ — then that is arti­fi­cially inflat­ing that par­tic­u­lar property’s price & there­fore the mar­ket in gen­eral.

    Aus­tralia is obsessed with auc­tions, so if you want to buy a prop­erty its a lit­tle hard to avoid!

  • Kevin

    Who made it on to Fox Busi­ness Chan­nel last night?

    Yeah yeah I do watch it lol

  • blueinca

    Ken said: “blueinca, I sug­gest that if you have prob­lems with auc­tions, avoid them and get over it, your con­cerns aren’t rel­e­vant to this blog. .”

    arrgh duh… you can over-intel­lec­tu­al­ize all you want about debt dri­vers, but at the end of the day, peo­ple pay­ing more for House-Prices than what they are gen­uinely worth is rel­e­vant to the debate. If an auctioneer/vendor is allowed to sim­ply ignore what the mar­ket believes the prop­erty is worth/willing to pay and sim­ply say- ‘well, that isn’t enough- you are sim­ply going to have to bid or nego­ti­ate at above this amount’ — then that is arti­fi­cially inflat­ing that par­tic­u­lar property’s price & there­fore the mar­ket in gen­eral.

    Aus­tralia is obsessed with auc­tions, so if you want to buy a prop­erty they are a lit­tle hard to avoid!

    Any manip­u­la­tions are only a minor fac­tor in the pric­ing of prop­erty” … auc­tion stops at $450,000. Auc­tion­eer says “no, we believe the prop­erty is worth more than that- we’ll make a vendor’s bid of $50,000”, some­one maybe bids because they are desparate to secure a home, but its still not enough so Auc­tion­eer announces another $50,000 Ven­dors bid.… And you call this behav­iour a “minor fac­tor” — I’m sure those bid­ding wouldn’t describe hav­ing to pay $100,000 more than should nec­es­sary (what the mar­ket thought it was worth) as “minor”

  • Retro

    Well Blueinca I have to agree with Ken. If you don’t like it don’t bid. If the prop­erty is really worth what you think it is the nego­ti­a­tions will fail and the ven­dor will still have a prop­erty he wants to get rid of. Real­is­ing this he will attempt to sell it again know­ing now it is less valu­able than he first thought and being more will­ing to accept a lower price, or take it off the mar­ket until con­di­tions are more favor­able.

    The ven­dor bid is the best of both worlds I think because there is trans­parency , if it is removed you just go back to the bad old days of dummy bid­ders and you may well be get­ting hacked even more with­out even know­ing it.

    I think you have to have a real­ity check and just hang in there. Either you will get what you want at the price you want even­tu­ally or you have to realise your view of house prices is the one that is incor­rect and bite the bul­let and pony up the dif­fer­ence!!

    Ven­dors have an expec­ta­tion of the price but they don’t set it!!! The buy­ers do!!!

  • Ken

    blueinca, they aren’t forced to pay the addi­tional money. If peo­ple are stu­pid enough to keep bid­ding when the only per­son they are bid­ding against is the owner then they deserve what­ever they get. In the absence of a ven­dor bid all that would hap­pen is that they would nego­ti­ate with the owner after the auc­tion if it hasn’t reached the reserve. The option is always there for the owner to set a min­i­mum price, it is known as the “reserve”.

  • Ishtar Rubin

    what an extra­or­di­nary com­ment. This whole forum is about the amount of per­sonal debt in this coun­try- most of it attrib­ut­able to House prices/affordability etc, so how any­one can jus­tify Ven­dor Bid­ding etc as some­how fair is beyond me.

    Banks & Real Estate Agents are part of the Infla­tion Indus­try- they each com­pli­ment the other in forc­ing peo­ple to pay more than they should be. Prop­erty prices rise forced up par­tially by, in the past by dummy bid­ding, & now legit­i­mately through ven­dor bids. The Banks then have been happy to approve loans (and there­fore debt!) to peo­ple buy­ing in these cir­cum­stances, thereby ful­fill­ing the cycle of accep­tance.

    Some of you seem to sub­scribe to the view that just because such prac­tices have occurred over the years, that some­how it shouldn’t be chal­lenged, and that it is ok. 

    Of course as the mar­ket declines, such prac­tices are going to be less likely to work, given there are less peo­ple able to afford prices, but unfor­tu­nately the die has already been set- its too late- the accep­tance of these prac­tices dur­ing the ‘good times’ have forced prices up to their unsus­tain­able lev­els we have right now.

  • Retro

    Well Ishtar I couldn’t agree with you less. While agree with you that this site is designed to warn of the eco­nomic impli­ca­tions of exces­sive debt and to warn of the pos­si­bil­ity of decreas­ing prop­erty (and other asset) val­ues I don’t believe that it is here to deter­mine the price of hous­ing or how the inter­ven­tion of agents has inflated these. 

    It seems to me that the major­ity or con­trib­u­tors on this site are less wor­ried about the debt lev­els and econ­omy of Aus­tralia and more con­cerned about when hos­ing prices are going to become low enough that they can get into the mar­ket to pur­chase a prop­erty, most of them hop­ing for a fall in price inline with Steve’s pre­dic­tions.

    You can stand around as long as you like for a prop­erty to fall to 40% of it’s peak “value” if you believe that is all it is worth, that is fair enough. Doesn’t mean that it will hap­pen, and as long as there’s the will­ing­ness of another buyer to go that 1% higher or seller unwill­ing to go that 1% lower you won’t have any­thing to show for it regard­less of ven­dor bids.

    I am only look­ing at things as they are, if you feel that ven­dor bids are uneth­i­cal or that bank lend­ing stan­dards need fur­ther reg­u­la­tion your local MP would be the best point of call. I would be inter­ested to see how peo­ple would feel if the shoe was on the other foot and they were try­ing to sell a prop­erty whether they would still be so opposed??

    I believe Steve recently did try to sell a prop­erty unsuc­cess­fully, per­haps he would like to com­ment?

  • blueinca

    1%” obvi­ously you’re using this exam­ple fig­ure as a joke, so we can ignore that.

    If you are at an auc­tion as an inter­ested party and some­one else (yes- stu­pidly — agreed) bids after a vendor’s bid, then if you really want the prop­erty you have to bid above that- so it’s a trap. 

    In an era where we are in 3 times more debt than at any other point in his­tory- any sort of prac­tice that pushes house prices higher (we all agree they are way too over­val­ued) must be frowned upon.

    I hardly think tak­ing the mat­ter to your MP is plau­si­ble- the gov­ern­ment has made it legal- ie: its per­fectly fine! (oh yeah but they are part of the Infla­tion Indus­try as well, aren’t they?- higher prices = higher stamp duty — and doesn’t John Brumby love putting his grubby hands out for more & more).

    Ven­dors have an expec­ta­tion of the price but they don’t set it!!! The buy­ers do!!!” — if you really believe that you are liv­ing in fan­tasy land- Agents/Vendors set the bench­mark, they tell you what they want for it- if the auc­tion sys­tem was a truly fair process, then I would agree, but its not- its slur­ried- the auc­tion­eer sets the agenda, and there­fore the ball-park fig­ure.

    Please don’t use the “reserve price” as some sort of reg­u­la­tory fair­ness- who sets the reserve?- ahhh… the same guy run­ning the auc­tion!

  • Bren­dan A

    The reserve price is set by the ven­dor & r/e agent; it is a fig­ure that has no cor­re­la­tion or con­straints to rea­son­able mar­ket value, its a fig­ure the ven­dor desires. Unless you pay some­where near or above that fig­ure you won’t be able to pur­chase the prop­erty. You can say what you want about peo­ple hav­ing a choice, but quite clearly peo­ple over the last decade have made the choice to buy into debt. If the banks didn’t lend them so much, they wouldn’t have been able to pay these high prices.

    So, from this point I totally agree. Ven­dor bid­ding and the like are def­i­nitely a fac­tor in this whole over-val­u­a­tion of prop­erty & acu­mu­la­tion of debt.
    This is very

  • Robyn H

    The reserve price is set by the ven­dor & r/e agent; it is a fig­ure that has no cor­re­la­tion or con­straints to rea­son­able mar­ket value, its a fig­ure the ven­dor desires. Unless you pay some­where near or above that fig­ure you won’t be able to pur­chase the prop­erty. You can say what you want about peo­ple hav­ing a choice, but quite clearly peo­ple over the last decade have made the choice to buy into debt. If the banks didn’t lend them so much, they wouldn’t have been able to pay these high prices.

    So, from this point I totally agree. Ven­dor bid­ding and the like are def­i­nitely a fac­tor in the whole over-val­u­a­tion of prop­erty & acu­mu­la­tion of debt.

  • Will

    the reserve price is set by the Auc­tion­eer & Ven­dor. It bears no cor­re­la­tion to rea­son­able mar­ket value. If you don’t pay some­where near or above the reserve you will be unsuc­cess­ful in pur­chas­ing. This was very much the case up until recently when we were rid­ing the ‘goldilocks’ wave.

    So from this point, it def­i­nitely is a fac­tor in mak­ing house prices unaf­ford­able & adding to debt in this coun­try.