The RBA doesn’t get it

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The deci­sion of the RBA Board to leave the cash rate at 3.25% today con­firmed that its mem­bers don’t under­stand the econ­o­my.

There was an inkling of this in the state­ment by Board mem­ber War­wick McK­ib­bin ear­ly last month crit­i­cis­ing the Rudd Gov­ern­men­t’s stim­u­lus pack­age (“Reserve bank direc­tor oppos­es pack­age”, SMH Feb­ru­ary 6):

A RESERVE Bank board mem­ber has expressed con­cern about the size of the Fed­er­al Government’s $42 bil­lion fis­cal stim­u­lus pack­age… Pro­fes­sor War­wick McK­ib­bin also accused the Gov­ern­ment of play­ing pol­i­tics with the eco­nom­ic slow­down and warned that this could shat­ter frag­ile con­sumer and busi­ness con­fi­dence.

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Cri­sis? What Cri­sis?”

It risks turn­ing what isn’t a cri­sis into a cri­sis,” he told the Her­ald yes­ter­day.

Pro­fes­sor McK­ib­bin, a promi­nent econ­o­mist from the Aus­tralian Nation­al Uni­ver­si­ty, is one of six non-exec­u­tive direc­tors who sit on the RBA board with the cen­tral bank’s senior exec­u­tives and Trea­sury sec­re­tary Ken Hen­ry.

If it is a cri­sis — and I am not sure we are in a cri­sis — that sug­gests mak­ing the cash hand­outs even big­ger will be prob­lem­at­ic.”

McK­ib­bin is a Pro­fes­sor of Eco­nom­ics at the ANU. If any evi­dence were need­ed of how neo­clas­si­cal eco­nom­ics hin­ders rather than helps to  under­stand the work­ings of the econ­o­my, this state­ment pro­vid­ed it.  Now the Board has sung a sim­i­lar tune, and halt­ed its recent pro­gram of inter­est rate reduc­tions, because “notwith­stand­ing evi­dent eco­nom­ic weak­ness at present, the Board judged that the stance of mon­e­tary pol­i­cy was appro­pri­ate for the moment. The Board will con­sid­er the posi­tion again at its next meet­ing.” (The RBA’s state­ment announc­ing its deci­sion today)

In fact, the stance of mon­e­tary pol­i­cy has always been inap­pro­pri­ate. By ignor­ing asset price bub­bles, and the debt lev­els that finance them–and yet res­cu­ing the finan­cial mar­kets at every crash–the RBA and its cousins around the world have encour­aged debt and asset price lev­els to reach heights that would have been impos­si­ble in an unreg­u­lat­ed sys­tem. Far from being the cus­to­di­ans of our eco­nom­ic well­be­ing, they have added to the ten­den­cy the sys­tem already had to cause finan­cial crises.

It was also only a year ago–at its March 2008 meeting–that the RBA last increased rates by 0.25%. The cri­sis that Pro­fes­sor McK­ib­bin isn’t sure about is now dat­ed from August 9 of 2007–the day that the BNP closed three of its funds because of their expo­sure to the sub­prime cri­sis in the USA. So more than six months into a peri­od when those in the real hot seats were real­is­ing that some­thing was on fire–and it was debt, not inflation–the RBA was still obsess­ing with dous­ing the smoul­der­ing ruin of infla­tion.

Here are a few charts that illus­trate that, far from being cus­to­di­ans of our pros­per­i­ty, Cen­tral Banks have risked it by using a fal­la­cious the­o­ry of eco­nom­ics to deter­mine their inter­ven­tions. First­ly, the US’s col­laps­ing share mar­ket bub­ble was the biggest in his­to­ry, far dwarf­ing the 1929 bub­ble:

Sec­ond­ly, the USA had not one asset price bub­ble but two:

Third­ly, this was financed by an unprece­dent­ed lev­el of debt. With­out the  Fed­er­al Reserve’s med­dling under Greenspan, it is quite con­ceiv­able that there could have been a crash in 1987. Though dam­ag­ing, this would have had far milder impli­ca­tions for the real econ­o­my than the crash we are expe­ri­enc­ing now:

Final­ly, this isn’t just an Amer­i­can prob­lem. While many Aus­tralians like to think that this coun­try is bet­ter reg­u­lat­ed than Amer­i­ca, we have been play­ing exact­ly the same debt gam­ble that the Amer­i­cans have. We now have debt lev­els that are more than twice as high as those that ush­ered in the Great Depres­sion, and 75% high­er than those that gave us the Depres­sion of the 1890s:

Our aggre­gate debt lev­el is low­er than America’s–mainly because we don’t have the same lev­el of finan­cial sec­tor debt–but our house­holds are even more indebt­ed in the aggre­gate than are Amer­i­cans, and the rate of growth of house­hold debt was sub­stan­tial­ly high­er here in the last 20 years than it was in the USA. We will enter a cri­sis when our lev­el of delever­ag­ing approach­es those already being seen in the USA.

When delever­ag­ing is in full swing, even zero inter­est rates won’t be enough to revive the econ­o­my. I expect the RBA to be forced by eco­nom­ic real­i­ty to renew its inter­est rate reduc­tion cam­paign with­in the next few months.

Real­i­ty is so much bet­ter a guide to eco­nom­ic pol­i­cy than neo­clas­si­cal eco­nom­ic the­o­ry…

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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.