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Federal

Sep 28, 2009

Glenn Stevens alert but not alarmed

The RBA Governor basically reckons the economy is in good shape, the banks are fine, and rates will rise when we think the economy is good and ready.

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In terms of recent comments, today’s opening remarks from Reserve Bank Governor, Glenn Stevens to the Senate inquiry looking into the Government’s stimulus payments were a simple restatement of last Thursday’s financial stability report and minutes from the September board meeting.

Briefly summarised: Australia has escaped the crunch, the economy is in good shape, the banks are fine and rates will need to rise when we think the economy is ready, which could be soon, or may not be, but don’t be alarmed!

Stevens told us nothing new and said nothing that the central bank hasn’t said publicly since the Governor’s appearance before the House of Reps Economics Committee six weeks or so ago.

And yet immediate reports carried the predictable ‘rate rise looms’ approach on the SMH website and the slightly more realistic Bloomberg report.

“Reserve Bank of Australia governor Glenn Stevens says Australia’s medium-term prospects are good as the economy emerges from the global economic downturn, and has again signalled that interest rates will rise,” the report on the SMH website started:

Rates will need to be raised in a “timely” way as demand picks up and record-low interest rates threaten to create economic imbalances, Mr Stevens told the Senate Economics References Committee today.

While Bloomberg reported:

Australian government stimulus spending will need to be eased and interest rates raised as the nation’s economy expands, central bank Governor Glenn Stevens said.

In due course, both fiscal and monetary support will need to be unwound as private demand increases,” Stevens said in Sydney today. “The bank has already signaled that interest rates can be expected, at some point, to move off their current unusually low levels.

That’s all self-evident, but you have to wonder if the store window dummy (AKA Senator Steve Fielding) would be able to understand what the Governor had said; that is rates will rise because the economy seems to be returning to normal levels of activity (still subdued in some areas) with demand and investment starting to regrow as businesses restart expansion plans.

The economy has missed a nasty slump and rates need to rise to reflect the growth pressures re-emerging, but Senator Fielding, along with the Federal Opposition want us to believe that the current near record lows for the RBA’s cash rate of 3% are somehow the ‘new normal’ of economic and monetary policy, instead of being abnormal.

But there is a very clear message for the Rudd Government as it basks in the reflected glories of the Leader’s US trip and Group of 20 triumphs.

The Governor explained, again for those on the committee unable to comprehend, that the fiscal stimulus (the cash payments) has peaked and is already winding down (and drops further from Thursday with the winding back of the first home buyers and first home owner builders grants).

In due course, both fiscal and monetary support will need to be unwound as private demand increases. In the case of the fiscal measures, this was built into their design.

The peak effect of these measures on the rate of growth of demand has probably already passed. The extent of support will tend to tail off further over the next year.

In the case of monetary policy, the Bank has already signalled that interest rates can be expected, at some point, to move off their current unusually low levels, as recovery proceeds.

These adjustments back towards more normal settings for both types of macroeconomic policy are what should be expected during the recovery phase of a business cycle. Our most recently released set of forecasts assumes they occur.

Such an outcome would mean that fiscal and monetary policy would be acting broadly consistently, as they did when they were moved in the expansionary direction when the economy was slowing.

The important word here is “normal”, or the phrase “normal settings. But, Mr Stevens reminded the Rudd Government of some unpleasant realities awaiting them in coming months; the need to cut and be controlled about what they do, and the need for some tough decision making, AKA “policy discipline”.

In both cases a degree of policy discipline will be needed. Policy frameworks will be valuable in enforcing that discipline.

On the fiscal side, the forward estimates provide an indication of the restraint needed to move the budget back towards balance and eventual surplus over time, as required by the Government’s medium term fiscal commitment.

On the monetary side, the inflation targeting framework the Reserve Bank has been following for a decade and a half will guide adjustments to interest rates. These will be timely and ahead of a build-up of imbalances that would occur if interest rates were kept low for too long.

These frameworks will, in other words, prompt the needed adjustments. It was the preparedness to make those adjustments in the past, guided by these very frameworks, that contained the build-up of imbalances in the upswing and which in turn earned us the scope to take bold measures to support demand when a recession loomed.

That means the central bank won’t hesitate to lift rates, as it didn’t in the 2007 federal election campaign, much to the continuing annoyance of the federal opposition, especially Malcolm Turnbull and Joe Hockey.

It’s clear from these comments that the RBA won’t hesitate if it sees “a build up of imbalances”. This is not a matter of ‘leaning into the wind” to try and prick asset bubbles before they develop, it simply means acting early to make sure that inflationary pressures do not erupt and strange the economy.

Mr Stevens has already signalled that he and the bank are eying the housing sector for the first signs of bottlenecks, wage surges and asset price rises from too much demand chasing too few houses.

The Rudd Government has been warned and will no doubt heed the message. Can Senator Fielding, and Messrs Hockey and Turnbull heed the other parts of his message as well: that healthy economies see interest rates rising and the unhealthy, like America’s, sees rates at 0% to 0.25% for an “exceptionally” long period of time, to quote the Fed chairman, Ben Bernanke because the economy is very, very weak.

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