RBA gets it wrong again

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The RBA has put rates up now on the belief that the financial crisis is behind us, and it has to return to its established role of controlling inflation.

That this decision was likely was flagged by the speech by Anthony Richards last week, which implied that the RBA, having ignored the house price bubble created by private credit growth in the preceding two decades, was worried about the renewal of the bubble initiated by the Government’s First Home Vendors Boost (I refuse to call it by its official name, since the money clearly went to the vendors, while the buyers copped only higher prices).

Needless to say I am all for trying to contain the house price bubble, which I regard as a disguised Ponzi scheme that has sucked Australian households into unsustainable debt levels. It is quite possible that the increase in interest rates (which is sure to be fully passed on by lenders and will add $20 a week to the servicing costs of a now commonplace $400,000 home loan), combined with the phasing out of the Vendors Boost, will be enough to prick the bubble–especially if it is followed by another rise next month.

But the RBA is doing this in the belief that the economy will return to normal after the recent mild recession–normal meaning growing at about 3% per annum in real terms, and faster than that as it rebounds from the recession.

Unfortunately “normal” in our post-War experience has  also involved a return to a rising private debt to GDP ratio. Every recession has involved a fall in debt-driven demand, and every recovery has involved a return to debt rising faster than income. As the global financial crisis has made many people realise, this is simply a formula for avoiding a crisis now by having a bigger one in the future.

I doubt that the RBA appreciates this even today. It is still mired in a neoclassical way of thinking about the economy, which myopically ignores the impact of debt-driven demand on the economy. This is why it can put up rates now in the belief that this will merely fine tune the economy’s performance–reducing the likelihood of inflation in the future.

I think it is likely that the RBA will achieve far more than it intends. The last time the RBA put rates up to attempt to control an asset price bubble that was already out of hand was back in 1989. That exacerbated the economic downturn that was already in train as the debt bubble of the 1980s started to collapse. I expect the outcome of this rate rise will be similar: a downturn that is already in train as a debt bubble bursts will be made worse by this increase in rates at a time of greatly heightened financial fragility.

The problem this time is I believe far worse than 1990. Then the household sector had a relatively low level of debt–the mortgage debt to GDP ratio was a comparatively trivial 18 percent, compared to its now record level of 87.5%. It was therefore possible for the financial sector to lend willy-nilly to households, something neoclassical economists facilitated by their enthusiastic deregulation of the financial sector.

Who is there to lend to today? All sectors of the economy except the government are carrying record levels of debt. Thus while the Vendors Boost and other enticements encouraged some additional borrowing by the already massively leveraged household sector–and gave us a household debt to GDP ratio that now exceeds America’s–I simply can’t imagine who (apart from the government) the financial sector can now sell debt to.

As a result, I doubt that we will see any sustained acceleration in the debt to GDP ratio, with the consequence that the debt-financed component of aggregate demand will be anaemic at best. Since that has been the major source of growth in aggregate demand for many years now, I expect that economic growth will be substantially less than the RBA anticipates.

If so, just as it killed a dragon that wasn’t there by its inflation-fighting rate rises up until March of 2008, it may be taming a lion that is sound asleep with its rate rises now. If economic growth does in fact stay well below levels that reduce unemployment in the coming two years, then there will be very good grounds for revoking the independence that the RBA has had in setting monetary policy. We may as well hand it back to the politicians, if the alternative is to leave it with neoclassical economists who don’t understand the dynamics of our credit-driven economy.

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268 Responses to RBA gets it wrong again

  1. MechanicalEngineer says:


    Deductability of mortgage interest will inflate the bubble higher as any mortgage amount’s repayment becomes more affordable due to the tax deduction achieved.

    As I understand it the US had home loan interest as a tax deduction. This just drove people to refinance homes to consume on the tax deductable equity in the home. This is clearly a bad idea.

  2. debtjunkies says:

    But ME their bubble did inflate to the level that ours has so therefore based on your argument maybe it is the tax deductibility of interest that kept their market from over inflating to levels ours are currently at.

    Seriously thou, if you then tax the capital gain made on housing then this will reduce the level of capital that continues to roll over in the property market inflating it further.

    If you give people a little each year (via a tax deduction)they may use it to boost savings, reduce debts or they may even choose to use it to consume, but if you give that same person an untaxed $100K profit from a sale that will get rolled into the new transaction bidding up the price.

    I think if you follow Steves idea of ensuring serviceability and deposit standards then you can mitigate the unrestricted bidding up of property as it is restricted by the borrowers ongoing capacity to service the loan (the interest tax deduction should not form part of the loan serviceability assessment).

  3. hbl says:


    You can zoom any web page in or out to suit your font size preference (View menu -> Zoom on both IE and firefox, or Control – / Control + keyboard shortcuts). Personally I like the current default size on this site.
    Or if you meant the size of the text entry box, you can type elsewhere and copy/paste into the form.

  4. ozmal says:

    Hi Steve,
    RE RBA and Interest Rates.
    While I find your web site very interesting and valuable for its information I am not really a blogger.
    I just want to say that Elliott Wave International have produced a chart of the Aust 3 Month Treasury Bill market rate and superimposed a line showing the RBA’s interest rate movements. The correlation is amazing. The same thing occurs with virtually all central banks. Central Banks follow the market rate. They do not lead the market, they do not set or control interest rates!
    My question is if this is true why do we have to continue with the delusion that central banks have any serious role to play?
    If all they do is follow the market rate, what useful work do they really do, what does all their so called research and analysis amount to?
    Any highschool student could look at the market rate chart and say “Gee time for interest rates to go up.”
    Hong Kong never had a central bank and did very well!
    Please keep up the good work.

  5. mulrax says:


    MechanicalEngineer is correct in his statement that home loan interest (principal residence) is deductible under US tax law.

    In the same way that high income earners are often attracted to negative gearing rental properties here in Australia, US taxpayers maintain large amounts of home loan debt as a simple, mainstream, tax minimisation strategy.

    I have known US residents who have talked about the need to buy a bigger house purely because they are “paying too much tax”. This is an established practice over there.

    At the same time, unlike here in Australia, there is no capital gains tax exemption in the USA, nor is there any discounting nor indexing of cost base with respect to the calculation of capital gains tax liabilities.

    US tax payers are able to, instead, defer the capital gain tax liability on disposal of real estate almost indefinitely with what’s called a 1031 Tax-deferred Exchange. These are applicable to all kinds of real estate (not just primary residence) and work on the premise that so long as the proceeds from real estate disposal are directed at one or more subsequent real estate acquisitions then the tax liabilty can be deferred.

    The spirit of these tax-deferreed exchanges is to maintain the buying power of funds extracted from real estate so that replacement property can be purchased. I think this is the sentiment that motivated the Australian Govt to provide a CGT exemption on the principal residence too, but the US rules have far wider application.

    So long as the proceeds from real estate disposals are always directed at further real estate acquisitions (of almost any type) the tax can theoretically be deferred indefinitely – or as a worst case left for their estate to
    pay when they are deceased.

    By and large, the US tax treatment of this is far more permissive than what we have here.


  6. debtjunkies says:


    I agree about the tax teatment from the US.

    I suppose my main point is that whatever tax arrangements we strive for, they should apply to all homeowners, occupiers and investors, that way at least everyone is on the same field and there is no favouring of one over the other.

  7. Alan Gresley says:

    @MMitchell 242

    “Alan, I personally think it is useful and insightful to have people post views such as your on this site. Typically others here are kind enough to provide thoughtful feedback, however, I do not think that one can expect any more than this from these posts, as this is not a political activist site, and others have suggested organising politically in the past and it has fallen flat (I am not sure that would work anyway). How to take ideas of reform and act on them seems to be an ongoing issue for many of the ideas presented here. Steve is working in one important area against large odds, but wider meaningful change is possibly beyond him and his blog. I think many people believe that significant change will not happen until things cannot continue as they are any longer, that said the least likely people to drive substantial change are those tied to mainstream interests and parties.”

    I agree with you fully here. I do not expect replies to some of my poignant statements. I am here at this moment since I discovered Steve via Max Keiser’s video “On the Edge with Steve Keen.” It was the last actions of Steve during this interview that made me admire him. Steve words were “to stop these financial bastards from doing what they did, this time around, ever again.”

    During my sojourn here on this blog, if I am able to shake the cobs web loose and allow critical thinking to occur by some, then I will be very satisfied. I fell comfortable among heterodox economist. Being a loner with no one to communicate with is frustrating. My father is the most accepting of my views but at the age of 79 he says that he does not want to have any more worries so he demises what he agrees with.

    Some say ignorance is bliss. Some say the answer to 1984 is 1776.
    Change is coming at a rapid pace of knots. This is a revolution (of great change) but few are unaware of the early stirrings. As Gerald Celente says, “when people lose everything, they lose it.” This is something which I hope will never happen but I am not ignorant to the fact that this is the direction where things seem to be heading. This is laid out clearly by Max Keiser’s latest interview though he doesn’t talk highly of the US public ability to see the obvious.


  8. mulrax says:

    Here’s something that may be of interest.

    To illustrate how far the shifting sands of the ecconomy can move, here is an article that suggests that Australians are about (or currently) returning to their profligate ways.

    I think the title should have been : “More Australians ‘looking to increase debt'” but I’m preaching to the converted on that.


    One wonders why, even if the ecconomy was really on the up, after having such a close call with disaster people aren’t throwing themselves into reducing their debts while rates are still relatively low and things are looking relatively rosy.

    Also, there is a growing sentiment that the rising AUD is a good thing. Check this article out.


    I should point out that most of Julia Lee’s articles degenerate into references to trend analysis techniques which I don’t approve of, but the message she sends is sure to be representative of what mainstream financial advisors are telling their clients so it’s worth using this as an early warning for investor behaviour etc.

    The short story is that the strong AUD is great if you are:

    * paying down foreign debt
    * making contractual payments or importing goods
    * purchasing foreign assets, including commodities that are denominated in USD (provided the AUD depreciates against foreign currencies again in the future).

    But there is no free lunch. The flip side of all of this is:

    * local debts will increase from their already high levels to service consumption at these ‘bargain’ prices
    * consumers will increasingly spend money on imported goods or overseas reducing local demand in some industry sectors (the travel agents and airlines could do well out of it though)
    * the motivation to outsource to foreign countries will increase at the expense of local industry and employment
    * exporters (eg: resources companies) will have lower revenues but the same overheads if they continue production at current levels. It’s true that these companies usually engage in currency hedging to manage the risk that the AUD will appreciate but they are rarely fully hedged because of the costs involved.
    * a cowpat is still a cowpat no matter what country you buy it from, so you need to pay cowpat prices to make it at all worthwhile (and have a use for a lot of fertiliser).


  9. scottmuz says:

    Hi Steve,

    I am an Australian living in the UK, married to an Englishwoman.

    You are doing Australia a great service by trying to highlight the massive Australian housing and credit bubble.

    I am shocked when I talk to my family, about their level of complacency about this. I suspect this is fairly typical in Australia. Although the UK seems to be in an even greater credit fueled mess, there is in the UK a growing realization that there is going to a tough couple of decades to get out of this.

    So to my request, I for sometime have been trying to get a good analysis of private debt to GDP ratios across a large range of countries. So I wonder if you would be able to put together an article comparing and contrasting private debt to GDP across the western nations. I suspect it would attract lots of readers as I have not been able to find anything about this on the web.

    Could you also explain clearly for non-economists about what causes private debt to GDP to rise? Is it running a persistent current account deficit in excess of GDP growth? Or is it simply due to a mis-pricing of credit?

    Thanks again,

    Scott Murray

  10. mulrax says:


    Referring back to your earlier post regarding the tax treatment of debt on principal residence vs other real estate, I agree that more consistency in the rules would (if nothing else) simplify our tax laws and leave less room for misinterpretation.

    I am not confident that the majority of homeowners would direct the proceeds of any progressively applied tax benefit to purposes such as paying down debt, though. They would be more likely to simply add it to their disposable income and spend it arbitrarily. Even if you or I might use every opportunity to reduce liabilities, it’s a cruel fact of life that people often do not act rationally. If we look at the behaviours that people frequently share when it comes to investment property, they are willing to gear to such high levels that in cash flow terms they are trading at a deficit, purely because there’s a tax deduction that will result. They justify this with the expectation of high returns from capital growth. In actuality, because the investment is neither cash flow positive or neutral they must make a capital gain equivalent of AT LEAST their average cost of carrying the investment just to break even in simplistic terms.

    Personally, I do not object to the idea of people being able to deduct interest expense for income producing activities. This puts the rules more or less in line with deduction rules for business expenses. My concern about deductible debt on investment property is that the deduction is permitted even when there is no reasonable expectation of the investment ever becoming cash flow positive purely because the loan balance is often never reduced (for fear of reducing their deduction entitlements). For a business to be able to claim tax deductions there must be a reasonable expectation that a profit will be made at some stage. To be considered a bona fide ‘business’ in the first place, there are also some other requirements like minimum revenues (as opposed to profits) and so on. There are some really annoying rules actually, but the objective is clearly to inhibit people calling particular activities a “business” purely in order to justify a swag of tax deductions that they would not otherwise be entitled to.

    I think any change to the tax treatment of the principal residence in Australia should encourage debt reduction, rather than encourage interest expenditure. Allowing deductible interest on home loans would really be doing the latter.

    To my way of thinking, interest and other deductions on investment property (and other passive investments) should be subject to similar (not exactly the same) rules as those used to qualify as a business – in particular I think there should be a reasonable expectation that the investment will be cash flow positive (generate a profit) within N years to discourage putting it on the ‘never-never’. This would not exclude people from ‘getting into the market’ but it would require them to make some concerted effort to pay down the loan to a reasonable level and therefore lenders may take some interest in only lending quantities for investment purposes that will satisfy the deductibility rules.


  11. ak says:


    The Chartalists think that they have the answer to your question:
    “what causes private debt to GDP to rise? Is it running a persistent current account deficit in excess of GDP growth? Or is it simply due to a mis-pricing of credit?”

    According to prof Mitchell it is because of budget surpluses combined with the Current Account Deficit.

    “We often read that the appropriate fiscal stance is to balance the federal budget over the business cycle. Some economists claim the goals should be to run a surplus on average over the cycle allowing for deficits in extreme downturns.

    Both goals would be fiscally irresponsible in Australia’s situation where our current account is typically in deficit. If the government balanced the budget on average and the current account deficit was in deficit over the business cycle then the private domestic sector would on average be in deficit (dis-saving) over that cycle. The decreasing levels of net private savings financing the government surplus increasingly leverage the private sector. The deteriorating debt to income ratios which result will eventually see the system succumb to ongoing demand-draining fiscal drag through a slow-down in real activity. In other words, adopting a growth strategy that relies on increasingly leveraging the private sector is unsustainable.

    The only way the private domestic sector can save if there is a current account deficit is for the government sector to run deficits up to the desired private saving. Government deficits “finance” private saving by ensuring that aggregate spending is sufficient to generate the level of output and income that will bring forth the private desired saving levels.”


  12. Vfe says:

    You have to hand it to the agents for pushing the boundaries. Is it any wonder Melbourne and to a lesser degree Sydney are ‘booming’.


  13. mulrax says:


    That was well spotted. As Benjamin Disraeli is attributed to have said (but popularised by Mark Twain), “There are three kinds of lies: lies, damned lies, and statistics.”

    Most forms of ‘market infomation’ seem to represent all three!

    It’s remarkable how radically statisical results can change when the sample is taken from a less than representative population. Even more remarkably, otherwise sound statistical information can be interpretted in radically different ways depending on what side of the fence the commentator sits on.

    The old (cynics) rule of thumb is that a real estate agent will always think of a reason why it’s a good time to buy property, a stock broker will do the same with stocks, and so on. And everyone is happy with themselves while the self-fulfilling prophecy holds true, except that it never lasts.

    Some of the popular dogma about investing kicks into play and we hear burned investors consoling themselves with “It’s okay, I’m investing for the long term”. How long is a piece of string?

    As J.M. Keynes said, “In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

    And of course the finance industry has a classic which they must state as a legal requirement, after justifying why investing in their product is a good idea based on a chosen window of past performance they say that “past performance is no indication of future performance.”

    (Apparently I’m in a quoting mood today)

    Distorted information, like that you drew everyones attention to, simply serves to muddy the waters further, so it’s a shame that more people in the general community aren’t aware of this farce.


  14. Skimick_99 says:

    The one point people seem to be missing is that the RBA is a private for profit bank, the same as the Federal reserve bank in America. The burning question is WHY do we “borrow” from a private bank that simple creates “credit” out of THIN AIR and lends it to us, and charges us INTEREST? Top economists out there are trying to fix a problem that can never be fixed from within, because the “system” is corrupt right from the start.

    All the politicians are LYING or stupid. We can end all of Australias problems tomorrow simply by creating out own money. Now, idiots out there will say “oh no inflation”…..wrong, governments would rise and fall based on their ability to manage the money system, which is THE MOST IMPORTANT ROLE a government has. Right now ALL MONEY is borrowed from banks and must be paid back plus interest, but where does the interest come from? IT MUST BE BORROWED! Imagine if the money just went round and round to service the nation! Right now money is sucked out of the country in interest payments. When the banks stop “lending credit” the nation grinds to a halt, when they give money away the nation booms, and inflation soars. The banks do this on purpose because they KNOW when they will row the economy and place their bets in the stock market (casino). It is a RIDICULOUS SYSTEM for we Australians to be living under. Eventually the bankers own everything, and we become nothing but slaves to them (if we are not already).
    Google “Money as debt 2, promises unleashed” and watch the video.
    No matter how you try to juggle the economy as it is, you will never win. The system MUST BE CHANGED permanently and forever. International bankers should have NO SAY in how we run our country. Anyone working against a truely Australian owned and operated money system should be seen as a traitor to Australians.
    Don’t be fooled, we DO NOT OWN OUR MONEY SYSTEM, no matter what garbage they try to tell you. The fact is our government BORROWS money when we could create it ourselves. Why should “bankers” be able to make money out of nothing then lend it to us? Maybe its the threat of TERROR by the banks against us if we ever try to break away? Is that the dirty secret? Is that why politicians talk tough to bankers but never do anything? Are they put there by bankers to ensure that their little scam is kept safe?
    Kevin Rudd said very clearly before being elected that “I will fight to keep the reserve bank independent!!”…..
    The road we are on right now is a DEAD END. The only way to keep it moving forward is mass immigration so new suckers out there can get house loans and the country gets more in debt. Thats the plan. Thats why they announced Australia will have 50 million people by 2050.
    Australia is a BUSINESS, owned by bankers, and you are the slaves.

    Lets kick out the bankers and take our country back!

  15. Karmaisking says:

    They are lying.

  16. The Outback Oracle says:

    ak…chicken and egg…cause and effect…logic and fundamental good sense tell us they have the cart before the horse! Well we didn’t ALWAYS run a CAD. It is CAUSED by something.
    Just thought I’d mix up a few metaphors.

    I keep wondering why the heck all these sages think Aus MUST run a Current Account deficit. The RBA, the Treasury and the Chartalists all take this as a given. You had Assistant Governor of the RBA, Philip Lowe, yesterday saying the CAD is CAUSED by the fact we have to borrow money form external Banksters! Great Scot!!!
    Aus has run a CAD for 50 years because the Credit and resulting Debt levels here are so badly managed at all levels…including Government Fiscal policy, the RBA and the Banks. I think it takes the work of a lot of geniuses together to take a country, which is probably the richest in the world in terms of resources, and turn it into one of the most indebted nations on the planet.
    Let’s not forget the Academia role in this…present company excluded!!!

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