High Noon Tues­day at the RBA

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In a Nutshell: I have a hunch that the RBA will follow its conventional “neoclassical” models and raise rates tomorrow, even though the economy is locked in “two speed” mode, and the global economy is racked by uncertainty. This would be a mistake: given unprecedented private debt levels and deleveraging by households and businesses, a rate rise would accelerate the economy’s decline into recession.

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The RBA meets 11 times a year to set the cash rate. At only 4 of those meetings—February, May, August and November—does it know the most recent CPI fig­ures before the meet­ing. When the Board meets tomor­row morn­ing, it knows that con­sumer price infla­tion was 3.6% for the year. Even the RBA’s pre­ferred trimmed mean, which shows a lower annual rate of 2.7%, has had two con­sec­u­tive quar­ters of 0.9%. Infla­tion is thus above the RBA’s tar­get zone of 2–3% on one mea­sure, and head­ing that way on another.

On infla­tion alone, the RBA is there­fore under strong pres­sure to raise rates. As a very con­ven­tional Cen­tral Bank, the RBA’s pol­icy deci­sions before the “Global Finan­cial Cri­sis” (as Aus­tralians call the Great Reces­sion) gen­er­ally fol­lowed what is known as the Tay­lor Rule. This rule argues that when the econ­omy is at full employ­ment and infla­tion exceeds 2 per­cent, the Cen­tral Bank should respond to an increase in infla­tion by rais­ing rates 1.5 times as much.

Fig­ure 1: Con­sumer Price Infla­tion in Aus­tralia

Accord­ing to the Tay­lor Rule, the RBA should raise its rate to 5 per­cent if it uses its trimmed mean as the mea­sure of infla­tion, and to a whop­ping 6.4 per­cent if it uses the stan­dard CPI. It’s infla­tion High Noon, the Price Rise Gang is in town, and the Sher­iff has to kill them with his anti-infla­tion Colt 45. As the Gary Cooper of Cen­tral Banks, the RBA there­fore sim­ply has to raise rates tomor­row: to do oth­er­wise would be cow­ardice.

That’s if you believe that the Tay­lor Rule actu­ally describes reality—I cat­e­gor­i­cally don’t. The only argu­ments in the Tay­lor Rule are the pol­icy inter­est rate, the infla­tion rate (actual and tar­get) and the growth rate (actual and tar­get). Like all neo­clas­si­cal mod­els, it ignores the role of pri­vate debt in the econ­omy. Now that pri­vate debt is falling from unprece­dented lev­els in Aus­tralia, two fac­tors that aren’t even con­sid­ered by the RBA’s exclu­sively neo­clas­si­cal eco­nomic mod­els are really deter­min­ing the economy’s direc­tion: the level of debt that is con­strain­ing con­sumers, and delever­ag­ing by both house­holds and firms that is reduc­ing aggre­gate demand. Pulling the inter­est rate trig­ger may blow the economy’s (and the Sheriff’s) brains out.

Fig­ure 2: The Tay­lor Rule in a Debt-con­strained econ­omy

The RBA thus faces a dilemma: if it sticks with its “fight infla­tion first” motto, it could trig­ger a much sharper slow­down in the econ­omy than its mod­els pre­dict.

This isn’t the first time the RBA has faced this dilemma. Back in the late 1980s, credit growth was astro­nom­i­cal, and the econ­omy was going gang­busters. After drop­ping rates in the after­math to the Stock Mar­ket Crash of 1987—and intro­duc­ing the First Home Own­ers Scheme which kick-started a prop­erty bubble—the pol­icy mak­ers (inter­est rate set­ting wasn’t the exclu­sive domain of the RBA back then) put up inter­est rates to con­strain the boom.

Their tim­ing was bad: the boom in credit ended at the start of 1989 when the cash rate was 15 per­cent, but they kept increas­ing the rate to a high of 18 per­cent by 1990. A year later, credit growth was neg­a­tive on a monthly basis (though still pos­i­tive year-on-year), and the RBA was in seri­ous backpedal mode, drop­ping inter­est rates as the econ­omy fell away beneath it in “The Reces­sion We Had To Have”. Dur­ing the Reces­sion itself, annual credit growth actu­ally turned neg­a­tive, and not merely coin­ci­den­tally, unem­ploy­ment rose to a post-WWII peak of 11.2 per­cent.

Fig­ure 3: Debt to GDP and Credit Growth

A cur­sory look at Fig­ure 3 might make you think that the RBA has less of a prob­lem this time. Credit growth is lower, and though it approached zero back in 2010, it had bounced from that level; and inter­est rates now are sub­stan­tially lower than in 1989.

But that is mis­lead­ing, because though credit growth is lower, credit growth is much larger com­pared to GDP than it was then—because debt has grown so much more than GDP. Though the rate of growth of credit was much lower in the last decade than it was in the 1980s—a peak growth rate of under 18%, ver­sus an aver­age of over 18% for 1980–1990—the con­tri­bu­tion that credit growth makes to aggre­gate demand is much larger today, because pri­vate debt is so much higher. Credit growth aver­aged 9.5% of GDP in the 1980s, ver­sus 13.5 per­cent from 1998 till 2008 (see Fig­ure 4).

Fig­ure 4: Debt to GDP level and growth rate

This has two impli­ca­tions. The first, rel­a­tively obvi­ous one, is that con­sumers are debt-con­strained as never before, and are there­fore not spend­ing. House­hold debt was less than 25 per­cent of GDP back when the cash rate was 15 per­cent in the late 1980s (see Fig­ure 5). It is now almost 100% of GDP—four times as high. There­fore, even ignor­ing the impact of repay­ing prin­ci­pal, an RBA rate of 4.75% today equates to 19% back then. House­holds are thus even more strained today than they were when the cash rate was 18 per­cent in 1990—and infla­tion today is a lot lower than it was in 1990, which makes the real debt ser­vice bur­den today even worse. So the level of house­hold debt is a major fac­tor in the sub­dued level of house­hold con­sump­tion.

Fig­ure 5: Debt by sec­tor as a per­cent­age of GDP

Glen Stevens seemed to acknowl­edge this point in his speech “The Cau­tious Con­sumer” last week, when he said that:

The period from the early 1990s to the mid 2000s was char­ac­terised by a drawn-out, but one-time, adjust­ment to a set of pow­er­ful forces. House­holds started the period with rel­a­tively lit­tle lever­age, in large part a legacy of the effect of very high nom­i­nal inter­est rates in the long period of high infla­tion. But then, infla­tion and inter­est rates came down to gen­er­a­tional lows. Finan­cial lib­er­al­i­sa­tion and inno­va­tion increased the avail­abil­ity of credit. And rea­son­ably sta­ble eco­nomic con­di­tions – part of the so-called ‘great mod­er­a­tion’ inter­na­tion­ally – made a cer­tain higher degree of lever­age seem safe. The result was a lengthy period of ris­ing house­hold lever­age, ris­ing hous­ing prices, high lev­els of con­fi­dence, a strong sense of gen­er­ally ris­ing pros­per­ity, declin­ing sav­ing from cur­rent income and strong growth in con­sump­tion.

I was not one of those who felt that this was bound to end in tears. But it was bound to end. Even if one holds a benign view of higher lev­els of house­hold debt, at a cer­tain point, peo­ple will have increased their lever­age to its new equi­lib­rium level (or, if you are a pes­simist, beyond that point). At that stage, debt growth will slow to be more in line with income, the rate of sav­ing from cur­rent income will rise to be more like his­tor­i­cal norms, and the finan­cial source of upward pres­sure on hous­ing val­ues will abate…”

This is a wel­come acknowl­edge­ment that changes in pri­vate debt have some macro­eco­nomic impacts, as Rob Burgess pointed out recently in Busi­ness Spec­ta­tor (see “Steve Keen’s RBA Con­vert”). But it is not enough: Stevens is still think­ing in neo­clas­si­cal terms, where every­thing set­tles down to “equi­lib­rium”, and he has not inte­grated credit into his think­ing. Though he obliquely acknowl­edges that ris­ing debt boosted aggre­gate demand, he doesn’t make the leap to see that aggre­gate demand is the sum of GDP plus the change in debt.

Stevens is hop­ing that once the “drawn-out, but one-time” change in house­hold lever­age set­tles down, tran­quil growth in income and con­sump­tion will return:

Can we look for­ward to a time when these adjust­ments to house­hold sav­ing and bal­ance sheets have been com­pleted? We can… the sav­ing rate, debt bur­dens and wealth will at some stage reach lev­els at which peo­ple are more com­fort­able, and con­sump­tion (and prob­a­bly debt) will grow in line with income… We could then rea­son­ably expect to see con­sump­tion record more growth than it has in the past few years.”

But this can only hap­pen if aggre­gate demand grows smoothly, which it can’t do unless debt not merely grows, but accel­er­ates. This is so because, since aggre­gate demand is GDP plus the change in debt, the change in aggre­gate demand is the change in GDP plus the accel­er­a­tion of debt. Accel­er­at­ing debt is thus nec­es­sary for a con­stant rate of growth of aggre­gate demand, but if debt con­tin­u­ally accel­er­ates, it must ulti­mately grow faster than GDP.

This is what hap­pened in the period from 1993 till 2008—when the RBA, like Cen­tral Banks around the globe, ignored the role of pri­vate debt even as the biggest debt bub­ble in his­tory devel­oped, because their neo­clas­si­cal mod­els of the world ignored the role of credit. The accel­er­a­tion in debt aver­aged over 2 per­cent of GDP in Aus­tralia between 1993 and 2008, so much of the recorded 3.8% growth in out­put over that period—and most of the growth in asset prices—was dri­ven by accel­er­at­ing debt.

Fig­ure 6: Credit Growth and Accel­er­a­tion in Aus­tralia (NB: labels are wrong way round; will amend later)

The GFC began when accel­er­at­ing debt rapidly turned into decel­er­at­ing debt. Aus­tralia atten­u­ated the sever­ity of the down­turn partly by encour­ag­ing house­holds back into debt with what I call the First Home Ven­dors Boost, so that even though the decel­er­a­tion in debt was severe, it wasn’t nearly as severe as in the USA. Our peak neg­a­tive from the Credit Accel­er­a­tor came in at minus 13%, whereas the USA’s maxed out at minus 27%–which is why the down­turn in the USA was so much worse than in Aus­tralia. Sec­ondly, again under the influ­ence of the First Home Ven­dors Boost, our Credit Accel­er­a­tor turned pos­i­tive again before it did in America—so the USA spent two years in a severe reces­sion while Aus­tralia recorded only one quar­ter of neg­a­tive growth.

Fig­ure 7: Credit Accel­er­a­tors for Aus­tralia and the USA

But herein lies the rub. Both coun­tries now face the same prob­lem that, with pri­vate debt lev­els at unprece­dented highs, debt will nor­mally tend to decel­er­ate rather than accel­er­ate, and this decel­er­a­tion could go on for a very long time. America’s level has already fallen by 40% of GDP since its peak in early 2009, and the cur­rent mas­sive increase in the Credit Accel­er­a­tor is due to a slow­down in the rate of growth of debt while debt is still falling.

Fig­ure 8: Pri­vate debt lev­els for Aus­tralia and the USA

Hav­ing delayed its delever­ag­ing via the First Home Ven­dors Boost, Aus­tralia is only just start­ing to delever—and its Credit Accel­er­a­tor is now turn­ing neg­a­tive after an anaemic rise till the end of 2010. This is the major cause of the “two-speed” economy—with the retail sec­tor and non-min­ing States stuck in reverse—and it won’t end until pri­vate debt lev­els fall sub­stan­tially from today’s lev­els.

For this rea­son, I don’t share Stevens’ opti­mism that this down­turn in con­sumer spend­ing will prove to be brief:

We can­not really know, of course, when that might hap­pen…. the rise in the sav­ing rate over the past five years … was … the biggest adjust­ment of its kind we have had in the his­tory of quar­terly national accounts data… That in turn means that the time when more ‘nor­mal’ pat­terns of con­sump­tion growth recur is closer than it would have been with a more drawn-out adjust­ment…. It is entirely pos­si­ble that, were some of the cur­rent raft of uncer­tain­ties to lessen, the mood could lift notice­ably, so I don’t think we need to be totally gloomy.

How­ever I do agree that the “new nor­mal” won’t be as strong as the “old nor­mal”:

But what is ‘nor­mal’? Will the ‘good old days’ for con­sump­tion growth of the 1995?2005 period be seen again?

I don’t think they can be, at least not if the growth depends on spend­ing growth out­pac­ing growth in income and lever­age increas­ing over a lengthy period…

To that rea­son, I add the prob­a­bil­ity that the Credit Accel­er­a­tor will remain neg­a­tive for most of the next decade, with the con­se­quence that the econ­omy will not ben­e­fit from the legit­i­mate role that expand­ing credit plays in a grow­ing economy—when that credit is used to finance invest­ment rather than Ponzi Schemes. Con­se­quently both Aus­tralia and Amer­ica are likely to return “dis­ap­point­ing” growth fig­ures: growth will tend to be below the 3% level that is needed to reduce unem­ploy­ment. This is already firmly the case in the USA, where growth has fallen well below the “Okun’s Law” level of 3 per­cent and unem­ploy­ment is once more on the rise.

Fig­ure 9: Real growth rates in Aus­tralia and the USA


Thus the “Tay­lor Rule” advice that the RBA should raise rates is extremely bad advice—but there are rea­son­able odds that the RBA will fol­low it and raise rates tomor­row.

The impact of such an increase will be dra­matic, and will amplify the case I have been mak­ing for a year now, that the RBA will be forced by eco­nomic cir­cum­stances to aban­don its “fight infla­tion first” obses­sion, and cut rates to stim­u­late a flag­ging econ­omy.

Sky News emails on interest rates

I was very glad to have Westpac’s Bill Evans agree­ing with me that rates should fall. This is a case I’ve been mak­ing for a year now, as evi­denced by the Sky News poll on rates that I’ve con­tributed to irreg­u­larly for the last year. Sky couldn’t locate a data­base of its pro­grams on the topic, but here is a selec­tion of my emails to Sky since mid-2010. I expected rate cuts to begin before now—which clearly didn’t happen—but this is in con­trast to all other com­men­ta­tors who thought rates would and should rise. I thought they might—but that such a move would be a pol­icy mis­take.

July 2010

Hi Steve

Can’t reach you on the mobile/landline …

Com­pil­ing our rates poll ahead of tomorrow’s deci­sion. Let me know yr call on:

· Tomor­row

· Decem­ber 2010

· July 2011

Flat mate–I’m in NY right now BTW, and the global roam­ing works about as well as the global econ­omy.

By Decem­ber, 0.25 to 0.5 below now.

July 2011, 0.5 to 1.0 below now.


October 2010

We’re con­duct­ing our Sky News inter­est rate poll for Novem­ber, hope you can help out again.

Will we see an inter­est rate rise in November/how much?

Rates by end March quar­ter?

Year from now?

Any­thing you’re par­tic­u­larly watch­ing out for Tues­day?

Thanks for your time in advance,

Again it’s the old Changi game–betting which cock­roach will cross a line first–but I think the RBA will hold off again because of the “unex­pect­edly low” infla­tion num­bers this week (inci­den­tally I’m one of the few expect­ing such num­bers because I think we’re headed for defla­tion glob­ally, not infla­tion).

The RBA is itch­ing to put rates up though, and they may well make up a rea­son for putting rates up by 0.25 at some time between now and Feb­ru­ary.

How­ever I’ll go with rates at 4.5% in March (unchanged) and below 4% in a year from now–not 3% as I have been call­ing for a while, but lower rather than higher.


February 2011

Good after­noon,

Time for our monthly inter­est rate poll, hope you can spare us a moment.

Will the RBA move on inter­est rates/by how much?


Where will rates stand the end of June quar­ter?

Same as now: 4.75%

One year from now?

Lower: of the order of 4%.

What com­ment are you most look­ing for­ward to in the state­ment?

Sur­prise about the fail­ure of infla­tion to hit the lev­els they were expect­ing. The last few CPI fig­ures have come in below their expec­ta­tions, mean­ing that the tight­en­ings they did in the antic­i­pa­tion of higher infla­tion have not been jus­ti­fied by the actual per­for­mance of the CPI.


May 2011


Hard to believe it’s almost May – I hope you don’t mind tak­ing a few moments to com­plete this month’s sur­vey.

Will we see a rate change on Tuesday/by how much?

Where will rates sit by the end of the Sep­tem­ber quar­ter?

May next year?

What are you look­ing for in the state­ment?

Many thanks again,

No change, though if they’re spooked by the recent CPI they might raise by 0.25.

Sep­tem­ber: 0.25 lower than now

May next year: below 4%

The state­ment: Some puz­zle­ment about the low rate of growth of credit; con­tin­ued euphoric expec­ta­tions about China; more neglect of the “Dutch Dis­ease” dan­gers posed to man­u­fac­tur­ing and tourism from the high dol­lar.


June 2010


Hope you can spare a moment to answer our monthly inter­est rate poll.

Will the RBA hike OCR tomorrow/by how much?

Where will rates be at the end of the Sep­tem­ber quar­ter?

June next year?

What will you be look­ing out for in the state­ment?

I expect them to keep rates on hold, but they could be brazen and increase them because their mod­els tell them they have to “strike first” to fight the infla­tion their mod­els pre­dict.

It would be a mis­take for them to do so, but far be it from me to argue that the RBA doesn’t make mis­takes!

I think rates might be at 5% by Sep­tem­ber and 4% or lower by this time next year.


July 2011


Inter­est­ing times – hope­fully you can spare a moment to com­plete this month’s inter­est rate poll by Mon­day after­noon.

Will there be an inter­est rate rise in August/by how much?

OCR by the end Decem­ber?

OCR in August (post meet­ing) next year?

What’s the main point you’ll be look­ing for in accom­pa­ny­ing state­ment?

I’ll write a post this week­end called “Blue Moon Tues­day at the RBA” because it’s only once in a blue moon that their deci­sion comes soon after the CPI change is known, rather than before.

I think they’ll hike 25 points on Tuesday–not because they should but because their “Tay­lor equa­tion” model tells them they should to stop infla­tion in its tracks.

The trou­ble is they also know that house prices are falling and growth is slow­ing in the US and Europe. So I think they’d rather not put them up, but for their own cred­i­bil­ity as “infla­tion fight­ers” they’re almost forced to.

I see that as an error, but it’s one I think they’ll make.

For the future, I think the econ­omy will go fur­ther backwards–accelerated by the .25 rate increase’s effect on house prices and households–and they’ll be forced into reverse.

So a 5% cash rate by Tues­day, 4.5% by Decem­ber and below 4% by next August.

In the state­ment I expect a con­fused inter­na­tional out­look, recog­ni­tion of the 2 speed econ­omy, and a “bal­ance of prob­a­bil­i­ties” call that the uptick in infla­tion jus­ti­fies the rate hike.

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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  • alain­ton

    sorry that should have been ever increas­ingly scarce resources

  • @ Alain­ton August 4, 2011 at 2:30 am | #
    “Tom Mur­phy an astro­physi­cist has just started a blog where he has turned his mind to social issues with some pow­er­ful insights.”

    He gets to the core prob­lem: “But not one of those steps will be taken if peo­ple (who elect politi­cians) do not crave this result.:

    The hope is that tech­nol­ogy will con­tinue to out­put mir­a­cle that will save us while main­tain­ing a “steady-state” socio-econ­omy.

    But, the prob­lems are not con­fronted and which are:

    1. The holis­tic cor­rupt­ing effects of the cur­rent Bank­ing Sys­tem in asso­ci­a­tion with the Polit­i­cal sys­tems.
    2. The unpro­duc­tive tap­ping by “inter­est” of all pro­duc­tion through the part­ner­ship of the polit­i­cal-bank­ing car­tels cum sys­tem.
    3. A bank­ing sys­tem of Usury that cen­tral­izes the gains from pro­duc­tion to itself alone.
    4. The Bank­ing sys­tem which is both a util­ity or “Pub­lic Ser­vice” as a Credit Dis­tri­b­u­tion Sys­tem (CDS) when self-con­ve­nient and self-prof­itable and a pri­vate free-enter­prise non Pub­lic Ser­vice CDS util­ity by whim and con­ve­nience.
    5. The impo­si­tion of the Bank­ing sys­tem that actu­ally forces the cog­ni­tive minds of the youth towards the goals and aims of itself that is to say, a heuris­tic cap­ture and train­ing sys­tem that brain-washes the sources of pro­duc­tion to its whim and fancy.
    6. A Bank­ing sys­tem that demands War and Geno­cide and Destruc­tion and the aris­ing exoge­nous spoils to renew its ener­gies within the energy dis­tri­b­u­tion cyclic sys­tem that our Planet expe­ri­ences, that is, dynamic Entropy.
    7. The resul­tant inten­si­ties of elite dom­i­na­tion which can wrest con­trol and change Law through Power alone.
    8. The lack of Ethic in the face of Power empow­er­ment by the peo­ple under the cur­rent polit­i­cal sys­tems (see below).
    9. Acknowl­edg­ing that human­ity is cur­rently expe­ri­enc­ing the most rapid and large scale advances in tech­nolo­gies and com­mu­ni­ca­tion it must be recog­nised that energy or lack of energy is not the prob­lem — or, if you pre­fer, will soon not be the prob­lem. But ethics is nec­es­sary to main­tain a bal­ance.

    Rothbard’s out­line for “anar­cho-cap­i­tal­ism“ or a prop­erly defined Anar­chy (con­sis­tent with ety­mol­ogy) as a form model in which the socio-eco­nomic could nest must be philo­soph­i­cal inves­ti­gated as an com­fort­able and long term, fully func­tion­ing “life-sys­tem” and cou­pled with the lat­est obser­va­tions from cel­lu­lar biol­ogy and its energy effi­ciency at cel­lu­lar level, but I acknowl­edge that this requires that man needs to becomes more intel­lec­tu­ally aware while also the level of Pub­lic Ser­vice demands to be re-orga­nized to Gate-keep­ing as opposed to “employ­ment.

    We need the return of integrity, hon­our, courage, hon­esty, ded­i­ca­tion and com­pas­sion to Pub­lic Ser­vice and this will not be easy as the cur­rent global socio-econ­omy is dom­i­nated by the vested inter­ests of Power cor­rupted elites, as can eas­ily be seen, and damn near every­body wants to join the club and share in the spoils. This model is not sus­tain­able so I believe after much con­sid­er­a­tion of many years, that this, our cur­rent sys­tem must and will burn — col­lapse, if you will — in order to pre­pare the global milieux for the nec­es­sary change.

    Eth­i­cal right is largely abstract; legal right is mostly con­crete. Eth­i­cal right the just man wishes to be estab­lished; legal right is already estab­lished. Eth­i­cal right and legal right mutu­ally exclude each other; where one pre­vails, the other can­not endure. One is founded on power, on might; the other on jus­tice, on equal­ity. One appeals to the sword to set­tle mat­ters, the other appeals to the judg­ment of men. For illus­tra­tion: Gov­ern­ments have the right to do wrong; that is, they have the power, the legal right, to do any­thing they choose, regard­less of whether it is good or bad — and their choice is usu­ally bad from the eth­i­cal stand­point. Gov­ern­ments can and do invade nations, rob the peo­ple of their prop­erty, enslave or kill the inhab­i­tants; all in per­fect accord with legal rights, but in gross vio­la­tion of eth­i­cal right. Let it be under­stood that the right of a gov­ern­ment is coex­ten­sive with its power; it has not the right to invade, enslave or kill the peo­ple of a stronger nation or gov­ern­ment, for it lacks the power on which this right is based; but, hav­ing the power, it has the right to com­mit these acts against a weaker nation. Let us not mis­take things as they are for things as they ought to be. ” Charles T. Sprad­ing

    Thanks for the link; inter­est­ing but I don’t favour his assump­tions.

  • A num­ber of peo­ple won­dered why I wrote this post. A quick look at Chris Joye’s lat­est piece in the Busi­ness Spec­ta­tor should explain it to you: the infla­tion hawks in the RBA were gun­ning for a rate increase on Tues­day, and I wanted to do my bit–along with oth­ers like Robert Gottliebsen–to argue against one.

    Here’s Gottliebsen’s piece, for those who didn’t see it


    And his pos­i­tive reac­tion when rates remained on hold:


    Chris Joye, as an infla­tion hawk with strong links within the RBA, today expressed his frus­tra­tion that they didn’t pull the trig­ger:


    Chris’s tim­ing of this piece–on a day that mar­kets across the world are tank­ing and fear of a return to reces­sion is now widespread–is amaz­ing.