Josh Frydenberg has succeeded in putting his most powerful critic, Reserve Bank governor Philip Lowe, back in his monetary box.
The RBA has surrendered to the federal government before Tuesday’s board meeting.
Nearly all the reporting of Dr Lowe’s Leslie Melville Lecture last week was devoted to our usual preoccupation with interest rates/housing prices.
Largely overlooked was an ominous retreat from drawing attention to the Morrison/Frydenberg government’s policy shortcomings.
It seems there will be no more embarrassing suggestions from Dr Lowe about what the government should be doing to sustain Australia’s economic growth.
Specifically, Dr Lowe declared: “I want to emphasise that the discretion we have and our broad mandate to promote the economic welfare of the Australian people do not constitute a licence for the Reserve Bank Board to pursue or advocate economic policies outside our area.”
Well that’s certainly a change of heart.
As deputy governor and governor, Dr Lowe has not been at all shy about advocating economic policies outside the RBA’s traditional area.
Most famously, Dr Lowe has been telling the federal government for five years that it should be investing more in infrastructure and people.
(For the record, federal spending on infrastructure has gone backwards for the six years the coalition has been in government. There is a promise to increase it over the next few years, but by 2024 in real terms it will be back to what Joe Hockey was promising in 2014.)
HSBC Australia chief economist Paul Bloxham has even graphed the RBA’s increasing call for fiscal help. IFM economist Alex Joiner summarised it: “First it was asking for policy assistance, then in 2015-18 it was intermittently pleading – now in 2019 it is on its knees begging.”
The graph was drawn before last week’s speech. If it was up to date, the line would plunge to zero.
Dr Lowe’s lecture ran to 4500 words.
The word “infrastructure” occurred only once – and then it was in an international context of ageing populations requiring less infrastructure investment: “Slower population growth means there is less need to add to the capital stock to accommodate more people. Less home and other building is required, and there is less need to invest in infrastructure to meet the needs of a growing population. While there are some specific areas where more investment might be needed, the overall effect of lower population growth is to reduce investment.”
That was it. A 180-degree flip with pike.
No more of the free and frank advice the RBA had been providing as it explained why it was a very bad idea for the government to rely on the bank cutting interest rates to do all the heavy lifting.
So we’re stuck with a government and central bank primarily relying on reflating housing prices to stimulate the economy, getting Sydney and Melbourne prices back to setting new records.
If that sounds like ridiculous, third-rate policy, it’s because it is.
There are credible forecasts that house prices in the two biggest cities will be back to record levels by the middle of next year.
Too bad about ramping up household debt levels further, the social costs of very expensive shelter, increasing inequality by inflating asset prices and, as Dr Lowe said: “One probable consequence of high levels of debt is that people are more careful with their spending and are less inclined to take on yet more debt. This is especially so when income growth has disappointed, as it has over recent times.”
Catch 22 – promoting more debt to get people spending even while more debt with sub-standard wages growth makes people wary of spending. Go figure.
As explained by RBA deputy governor Guy Debelle last month, the RBA expects rising prices to turn around falling housing construction and increase housing turnover while the “wealth effect” gets us spending more.
After a low point for housing construction next year, Dr Debelle is tipping a hot housing industry in 2021.
Along with a pickup in mining investment, that’s pretty much what the RBA’s perception of a “gentle turning point” in economic growth is based on.
A “gentle turning point” is, by self-description, weak. And it assumes the much-discussed international headwinds don’t blow hard here.
Meanwhile, the federal government’s pursuit of a surplus above all is tightening fiscal policy, working against the stimulus of cutting interest rates.
Thus, while the market is not expecting an interest rate cut on Melbourne Cup day, there’s a good chance of another reduction before too long.
Not that Dr Lowe will blame the federal government – he’s in defensive mode.
Aside from promising not to mention the “I” word or advise on fiscal policy, a large part of last week’s speech was devoted to praising and defending the RBA’s rare triple mandate.
One might wonder if that had something to do with the new agreement between the RBA and the Treasurer that is yet to appear, though it will soon be six months since the election.
Most central banks are given only one or maybe two key responsibilities.
As Dr Lowe proudly explained last week and to an International Monetary Fund audience earlier last month, the RBA has three.
- The stability of the currency of Australia
- The maintenance of full employment in Australia, and
- The economic prosperity and welfare of the people of Australia.
The lack of any specific mention of inflation might horrify earlier generations of central bankers, but Dr Lowe believes in meeting the triple mandate by focusing on inflation control, the labour market, the payments system and financial stability.
“Dealing with these matters is our contribution to our collective welfare.”
And, in his own words: “I also want to emphasise that the flexibility of our inflation target and our broad mandate – and the discretion it allows – requires a high level of transparency and accountability from us. When we make decisions, there is always an element of judgment and we have to wrestle with difficult trade-offs, where reasonable people can come to different judgments.”
That sounds to me suspiciously like ticking off the sort of issues that could be sticky in negotiating a new agreement between Treasurer Frydenberg and the RBA.
We’re left to imagine what Mr Frydenberg might have threatened our central bankers with to make them toe the line – another embarrassing photo op?
With the government beyond criticism, Dr Lowe remains free to criticise business for not investing in new capital, for having hurdle rates that are too high.
“At low interest rates, many investments that didn’t make sense at higher interest rates should now make sense,” he said.
“This is especially so for investments with long-term payoffs, because future returns no longer need to be discounted as highly. This means that low interest rates give us the opportunity to lengthen our horizons and think about projects with really long-term payoffs.”
But that very same point can and should be made about government investment now – oops, that’s “outside our area”.
It wasn’t always thus. I’ve repeated then-deputy governor Lowe’s fine remarks to a 2014 parliamentary committee before and they are worth repeating again: “At the end of the day, monetary policy can’t be the engine of growth in the economy. We can help smooth out the fluctuations. We can’t in the end drive the overall growth in the economy.
“It’s clearly structural issues that do that … Australia is going to be a high-wages, high-productivity, high-value added economy – that’s where we want to be, that’s where we could be, that’s where we should be.
“If we’re going to find ourselves in that position and sustain ourselves there, then people need to be able to take risks. They need to be able to be rewarded for risks and we need to innovate to find new ways of doing things better.
“So I think it’s somehow enlivening the entrepreneurial and risk-taking culture, innovation culture, so that we can be the type of country that has high value-added, high wages and high productivity. I think culture’s important.
“In my perspective, I think our society is becoming too risk adverse, the way we think about risk has got distorted and we’re not paying enough attention to returns and we’re paying too much attention to risk.
“I think if we invest more and more effectively in education, in human capital accumulation and infrastructure, so it’s risk taking, education, infrastructure, they’re the things that are going to help us be a high wage, high productivity, high value-added economy.
“But the details here aren’t things the central bank are expert in, but they’re the ingredients to be a successful economy in the next 20 years.”
He’s been saying much the same thing in various forums ever since. Until last week.
If he keeps the promise to limit himself to monetary policy, Mr Frydenberg will be happy but the country will have lost an important voice.
And the economy will be left with pursuing even weaker monetary policy.
The governor has said it’s extremely unlikely Australia will have negative interest rates – that’s what Europe and Japan used to think, too.
Writing about the changing of the guard at the European Central Bank, a British commentator whose name I can’t find thundered: “If anybody out there can find one sound argument why or how the persistence of negative interest rates should or could be held up as a mark of success, then may they please step forward. When it comes to beggaring future generations, I can think of nothing worse.
“This is where we could do with our very own financial version of Greta Thunberg to rise up and declare ‘How dare you!’
“An entire generation’s retirement savings is at risk of being turned to dust at a time when states are already lumbered with more unfunded pension liabilities than you can shake a stick at.”
He was, of course, writing about Europe, but that’s where too much reliance on monetary policy ends up.