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The RBA's decision not to reduce rates this month caught most pundits by surprise—including me. Given the international and local data, I thought they'd err on the side of caution and cut rates.
As I always note when asked to call what the RBA will do next, this is a call on how another body will respond to what they perceive as the economic data and the direction their model of the economy predicts the actual economy will move in. That's closer to picking which cockroach is going to walk out of a circle first in a Changi prison gambling den than it is to economic forecasting per se (which is dubious enough activity in itself). So making a wrong guess about what the RBA will do is not the same as making a wrong economic forecast; you're just making a different forecast of the future than is the RBA.
The RBA's explanation for its decision shows that it is making a rosy call of both the current data and the direction in which the Australian economy is headed.
Information on the Australian economy continues to suggest growth close to trend… the unemployment rate increased slightly in mid year, though it has been steady over recent months… In underlying terms, inflation is around 2½ per cent… the Bank expects inflation to be in the 2–3 per cent range.
Credit growth remains modest, though there has been a slight increase in demand for credit by businesses. Housing prices showed some sign of stabilising at the end of 2011, after having declined for most of the year. The exchange rate has risen further, even though the terms of trade have started to decline … With growth expected to be close to trend and inflation close to target, the Board judged that the setting of monetary policy was appropriate for the moment.
As the Sydney Morning Herald editorialised, the RBA message was that the future looks good:
MOVE right along folks. Nothing to see here. By keeping interest rates on hold this week, the Reserve Bank is sending a subconscious message to borrowers: the economy is doing reasonably well. There is no need to panic…
Although we in NSW seem bogged Eeyore-like in our sad and dank little corner of the forest, glumly chewing our thistles day after day, perhaps we really ought to cheer up. Gloom is not just miserable in itself. When it comes to the economy, it's dangerous.
This is not the take that the majority of economic pundits have on the data—and for once, I'm with the majority. Normally the majority is bullish (because they have a Neoclassical perspective on the economy that largely ignores credit, and thinks the economy always returns to equilibrium) and I'm bearish (because I have a "Post Keynesian" perspective that sees credit as the key motive economic force, and believes the economy is always in disequilibrium).
The majority of economic pundits lined up with me for a change because there was a range of data that implied the economy was stalling. Firstly, unemployment has been trending up, and the "steady over recent months" phenomenon that the RBA referred to above was entirely due to a fall in the participation rate. Had this remained at the November level, the ABS unemployment rate would have jumped to 5.6% last month.
Secondly, a broader measure of unemployment maintained by Roy Morgan Research hit 10.3 percent—5 percent above the ABS figure. The ABS treats someone who has worked for one hour in the previous two weeks as employed, a definition that Roy Morgan rightly rejects:
"Surely if someone is not working, is looking for work and considers themselves to be unemployed, then they should be considered unemployed regardless of whether they happen to have done a couple of hours work here and there during the month?"
The ludicrous official definition of unemployment is a classic case of bureaucracies (including the United Nations International Labor Organization in this case) eliminating a problem by redefining it rather than solving it. Many people have criticised this definition (including Peter Brain from the National Institute for Economic and Industry Research, who found that over a dozen official redefinitions of unemployment had all reduced the recorded level); since the late 1990s, Roy Morgan has gone one better and conducted a monthly survey using a definition of unemployment that actually makes sense:
" According to the ABS definition, a person who has worked for one hour or more for payment or someone who has worked without pay in a family business, is considered employed regardless of whether they consider themselves employed or not.
The ABS definition also details that if a respondent is not actively looking for work (ie: applying for work, answering job advertisements, being registered with Centre-link or tendering for work), they are not considered to be unemployed.
The Roy Morgan survey, in contrast, defines any respondent who is not employed full or part-time and who is looking for paid employment as being unemployed. ” (Roy Morgan, September 2011)
Roy Morgan’s definition therefore necessarily records a higher level of unemployment than the ABS—and they are also a more legitimate measure of real unemployment. However their results are also more volatile, since their sample is smaller than the ABS’s, and the results are not seasonally adjusted.
Overall however, Roy Morgan’s figures are a more accurate indicator of the level of unemployment than the ABS’s, and also as a harbinger of where the ABS data may move in the future. The current gap between the two measures is the highest it has ever been—over 5 percent, when the average gap has been about 2.5 percent—and this implies that the next move in the ABS figures could be substantially upwards. Gary Morgan warned that the economy is a lot weaker than the RBA seems to think:
“Today’s Roy Morgan unemployment estimates strongly support anecdotal evidence of continuing job losses throughout Australia. Just in the past week we have been told that Westpac has announced 550 jobs to go; ANZ is axing 130 jobs; Holden will cut 200 jobs at its Adelaide plant; Toyota will cut 350 jobs in Melbourne; Reckitt Benckiser (maker of Mortein & Dettol) is to retrench 200 jobs at its Sydney operations; defence firm Thales shedding 50 jobs in Bendigo — these are just the most prominent examples of job losses occurring in the Australian economy!
“Economists and politicians are wrong to talk about a ‘tight’ labour market in Australia driving wage pressures. Wage demands (inflation) at the moment are being driven by unions — a small minority of the Australian workforce — not by a tight labour market with workers changing jobs to secure better wages and conditions. Today’s Roy Morgan employment estimates show why inflation in Australia is contained, and will remain contained — at its meeting next Tuesday the RBA must drop interest rates by at least 0.5% and probably more.”
If Gary Morgan is right, the RBA’s rosy forecast for the future will be shown to be in error. The primary source of that error will be not merely misplaced optimism, but reliance upon neoclassical economic models about the economy that ignore the role of credit just at the moment that decelerating credit is finally setting in in earnest in Australia, after being delayed by the First Home Vendors Boost.
The First Home Vendors Boost was the sole cause of the reversal of deleveraging in Australia after the crisis began, with the growth in mortgages more than offsetting the reduction in debt by the business sector.
With that artificial stimulus to credit growth over, credit growth is now decelerating in Australia, and causing unemployment to rise despite the offsetting impact of the resources boom.
Mortgage debt is now decelerating strongly, and taking house prices down with it.
From its comment that “Housing prices showed some sign of stabilising at the end of 2011″, the RBA appears to be buying the RPData spin that a one month upwards blip in their data series after 11 months of decline signals a bottom to the housing market. However a simple comparison of house prices here to those in Japan and the USA after their bubble economies burst makes it hard to argue that “Australia is different”.
Of course, at this stage it is too early to tell whether we’ll follow the long slow decline of Japanese prices, or the sudden fall that marked the USA. But by the end of 2012, Australia’s house price decline profile should be apparent.