Tuesday, March 30, 2010

Glenn Stevens' predicament: He wants us to believe interest rates are heading up without actually putting them up

I imagine it is a tough job being the nation's central banker. But the recent television interview with Glenn Stevens, RBA Governor, has made it quite clear the predicament he currently faces.

Stevens warned that property speculation is not the path to riches (the Real Estate Institute of Australia was apparently surprised by this statement). Obviously he is very worried about the stability of Australia's massive residential property market.  But to achieve the desired outcome, he needs to fool us all.

As I have mentioned before, the interest rate lever as a monetary policy tool is not exactly akin to a car accelerator. Sometimes we don't notice a change in speed because we don't have a speedometer to provide information - all we have are the other cars beside us as a reference point. When interest rate moves are made in predictable baby steps, we barely notice the relative change in speed with the cars beside us, and may not change our behaviour. However, if interest rate changes were sudden and unpredictable, we might get the message.

Steve Keen, amongst others, has noted that for monetary policy to be effective the public must be fooled. The IS-LM-BP model that underpins our understanding of monetary policy transmission fails under rational expectations.  If the public’s expectations are in line with monetary policy changes, they are ineffective. Expectations must not be met.

I am guessing his preferred outcome is for lenders to tighten standards on home loans and for buyers to be more cautious about taking on housing debt, so that he doesn’t actually need to increase the debt burden on the economy. He wants us to think interest rates are going to be higher in the future without actually having to follow through with the increases.


  1. I would guess that the RBA would have to receive support from the govt, but do you think it likely/possible that the RBA can impose a minimum LVR for residential and investment mortgages? or is this legislative, and hence would need to be prompted by the govt?

    As I guessed, and supported by todays AFR, business and personal loans are costing many more bp over cash rate than mortgages because of the criticism levelled at banks that try and raise rates above cash rate increases. I expect the likes of westpac would now like to re balance towards commercial and private loans, but to do so they'd need to increase mortgage rates for which they get panned. Hence the govt are adding more air to the bubble.

  2. Definitely. Expectations are the key. Cash and bond markets, and even FX to a degree, are the field where borrowers and lenders can express their views and arrive at a consensus. These markets move constantly, not only when the RBA makes a decision or statement. For most commercial borrowers with a longer dated debt profile, the cash rate is not nearly as important as 90day, 2 and 5 yr benchmarks.

    The RBA must also attempt to influence key factors such as the availability of credit and market confidence as well as the price of money. Typically we have seen excessive availability of credit at relatively high interest rates (pre-crunch) and very tight credit at low interest rates (crunch) so the RBA's role is not solely about the price of money.