What the RBA can and cannot do

Rajat left an interesting comment on my recent Australia post, with some quotes by top Australian policymakers:

Australia has a central bank (the RBA) that is reluctant to cut the cash rate further to avoid ‘financial instability’ due to (as Marcus says) asset price ‘bubbles’ ‘popping’. RBA Governor, Glenn Stevens, has called Sydney house prices ‘crazy’:http://www.sbs.com.au/news/article/2015/06/10/sydney-house-price-boom-crazy The media release accompanying every monthly RBA policy decision refers to property prices, particularly Sydney’s:http://www.rba.gov.au/media-releases/2015/mr-15-15.html

To me, it seems the RBA wants a certain type of ‘handover’from mining investment to other forms of growth. It seems comfortable with some increase in private consumption, but not too much. Stevens recently said:

“But the bigger point is that monetary policy alone can’t deliver everything we need and expecting too much from it can lead, in time, to much bigger problems. Much of the effect of monetary policy comes through the spending, borrowing and saving decisions of households. There isn’t much cause from research, or from current data, to expect a direct impact on business investment. But of all the three broad sectors – households, government and corporations – it is households that probably have the least scope to expand their balance sheets to drive spending. That’s because they already did that a decade or more ago. Their debt burden, while being well serviced and with low arrears rates, is already high. It is for this reason that I have previously noted some reservations about how much monetary policy can be expected to do to boost growth with lower and lower interest rates. It is not that monetary policy is entirely powerless, but its marginal effect may be smaller, and the associated risks greater, the lower interest rates go from already very low levels. I think everyone can see that.”

Stevens’ RBA deputy, Phil Lowe, recently said:

“I suspect that it is unlikely to be in our national interest for this more prudent approach to give way to household consumption once again growing consistently much faster than our incomes. This is something we continue to be cognisant of in the setting of monetary policy. Some decline in the rate of household saving is probably appropriate as the economy rebalances after the terms of trade and mining investment booms. But, given the position of household balance sheets, it is unlikely to be in our long-term interest for a consumption boom to be financed by a pick-up in household borrowing.”

However, it’s clear the RBA would love to see an increase in non-mining investment. RBA speeches frequently exhort businesses to invest in a similar manner as you once criticised Mark Carney for saying to Canadian businesses. For example, see this speech from Stevens last August:

“But the thing that is most needed now is something monetary policy can’t directly cause: more of the sort of ‘animal spirits’ needed to support an expansion of the stock of existing assets (outside the mining sector), not just a re-pricing of existing assets. There are some encouraging signs here. Nonetheless, if reports are to be believed, many businesses remain intent on sustaining a flow of dividends and returning capital to shareholders, and less focused on implementing plans for growth. Any plans for growth that might be in the top drawer remain hostage to uncertainty about the future pace of demand.”

The RBA would also like to see an increase in exports. The Governor’s monthly statements invariably refer to the level of the dollar and until very recently (with the AUD now down to US 70 cents from $US1.05 in 2011-13), included statements that “further depreciation seems both likely and necessary”: http://www.rba.gov.au/media-releases/2015/mr-15-11.html

Finally, while statements in support of supply-side economic reform are always welcome, to me it seems this recent speech by Stevens is a bit cheeky:

“Growth is important. And for a while now, there has not been quite enough growth. There has been growth, and more than in many countries. But, recent labour market outcomes notwithstanding, not as much as we ought to be capable of. “

Followed by:

“Reasonable people get this. They also know, intuitively, that the kind of growth we want won’t be delivered just by central bank adjustments to interest rates or short-term fiscal initiatives that bring forward demand from next year, only to have to give it back then. They are looking for more sustainable sources of growth. They want to see more genuine dynamism in the economy and to feel more confidence about their own future income.”


There’s a lot there, so let me give an overview of how I see these issues.

It’s fashionable to make wise sounding pronouncements about how monetary policy is not a panacea, and how we need a “balanced” approach, how we need to watch out for debt bubbles, and how fiscal must do its part, and how we need supply-side reforms, etc.

Unfortunately three issues get all mixed up here:

1.  The need to produce a stable path for NGDP (or perhaps nominal total compensation in the case of Australia.)

2.  The need for supply-side reforms to boost RGDP growth

3.  The need for financial market reforms to avoid excessive indebtedness.

Let’s clear up some misconceptions.  Monetary policy is a panacea for stable NGDP growth.  And you need stable NGDP growth (or nominal total comp.) regardless of what else is happening in the economy.  Monetary policy does not boost the economy by encouraging lending, it boosts the economy by encouraging more NGDP.  Higher lending is a side effect.

If there is excessive lending (due to moral hazard, tax breaks on debt, etc.) you still do whatever it takes to keep NGDP on target, but you also have tighter regulation of lending, so that more of the NGDP growth is non-credit oriented growth (like restaurant meals) and less is credit oriented growth (like housing.)

Monetary policy is not a panacea for a lack of RGDP growth.  Indeed the central bank should ignore RGDP.  Instead, policymakers should try to boost RGDP with supply-side reforms.

Australia’s not even at the zero bound, there’s utterly no reason not to do austerity right now.

One other point about Australia.  Watch the unemployment rate.  RGDP in Australia is distorted by mineral exports, which are not very labor intensive.  The RBA needs to keep the labor market close to equilibrium, by slow and steady growth in total labor compensation.  If RGDP and even NGDP falls and yet unemployment is stable, you have a pseudo-recession, not anything for the central bank to worry about.

HT:  Matt McOsker



12 Responses to “What the RBA can and cannot do”

  1. Gravatar of marcus nunes marcus nunes
    8. September 2015 at 17:01

    I hope the RBA finds “balance”:

  2. Gravatar of Major.Freedom Major.Freedom
    8. September 2015 at 17:05

    “1. The need to produce a stable path for NGDP (or perhaps nominal total compensation in the case of Australia.)”


    “3. The need for financial market reforms to avoid excessive indebtedness.”

    No that is incorrect. Inflation and debt are not separate at all. The Fed DEPENDS on the banks to expand credit in order for the aggregate money supply and volume of spending to increase.

    That is how money from the Fed is translated into higher aggregate spending and prices.

    If the banks don’t expand credit, then the Fed’s OMOs will not translate into higher aggregate spending or prices. The Fed does not purchase final goods and services directly.

    The error in your reasoning is conflating the mathematical ratio of base money supply to total spending, as the sole mechanism by which an increase in the money supply by the Fed causes higher aggregate spending.

    It is not the case that if the base money supply is $100 billion, while aggregate spending in a year is $10 trillion, that so-called velocity, through the so-called “hot potato effect”, is $10,000 to $100, or 100. Or, in other words, a dollar is spent on average 100 times a year.

    That is not how the monetary system works.

    What actually occurs is that if the Fed inflated the monetary base to $100 billion, they are depending on the banks to expand credit in a pyramid fashion of say 9 to 1, such that banks expand credit and thus the money supply (through redepositing the funds lent) by $900 billion. The total money supply is then $1 trillion, which is the actual foundation for aggregate spending to be $10 trillions, for a “velocity” of 10.

    To complain about “excessive debt” when one is also Complaining about

  3. Gravatar of Major.Freedom Major.Freedom
    8. September 2015 at 17:06

    …insufficient aggregate spending, is like a dealer of crack complaining about insufficient crack sales while decrying excessive crack usage.

  4. Gravatar of Major.Freedom Major.Freedom
    8. September 2015 at 17:16

    “If there is excessive lending (due to moral hazard, tax breaks on debt, etc.) you still do whatever it takes to keep NGDP on target, but you also have tighter regulation of lending, so that more of the NGDP growth is non-credit oriented growth (like restaurant meals) and less is credit oriented growth (like housing.)”

    And Sumner denies he is a socialist…

    Here he is advocating for the state to effectively take control over lending in a communist as opposed to a fascist manner.

    Reminj us all again how in the world could Congressmen know better than lenders and borrowers about how much should be lent and borrowed again?

    This is so common among aocialists. Their advocacies in one area of state activity has unintended consequences, and instead of admitting they were wrong, they advocate for more state activity to fix the unintended consequences.

    Thus creating more unintended consequences, and again more state activity to fix those.

    And on and on.

    I smelled Summer’s stink of socialism a mile away many years ago, and yet his acolytes denied it. Well read it and weep you so called “pragmatic libertarians” who seem to find it so easy to advocate for more state intervention when their other state intervention advocacies bloe up in their faces.

    Fools. The lot of you.

  5. Gravatar of E. Harding E. Harding
    8. September 2015 at 20:18

    @Major, you’re part right, part wrong. Debt-to-NGDP ratios can and do fall.
    @Major, don’t see anything Communist here. In fact, Sumner’s ideas on bank regulation may be more or less consistent with your views.

  6. Gravatar of ThomasH ThomasH
    8. September 2015 at 21:11

    Tinbergen said it all a long time ago.

    Monetary authorities regulate NGDP

    Financial sector regulators prevent excessive leverage, risk-taking.

    Governments invest in projects with positive NPVs and remove obstacles that prevent private investors from doing the same.

    I do think it is important, however to recognize that falling NGDP tends to raise risks in the financial sector and promote bad supply- side policies, so 1 is a quasi-necessary condition for 2) and 3)

  7. Gravatar of ThomasH ThomasH
    8. September 2015 at 21:14

    Sumner is not a Libertarian; he’s a garden variety Liberal, (The Liberal Garden is large and has many varieties).

  8. Gravatar of Rajat Rajat
    8. September 2015 at 21:17

    Thanks for the post, Scott. The Australian unemployment rate has risen from 5% to 6.3% over the last 3 years. FWIW, nominal wages growth and unit labour cost growth are at multi-decade lows. The RBA has acknowledged this and suggested that the slow wage growth has allowed UnN to stabilise at a lower level than they earlier expected: http://www.rba.gov.au/speeches/2015/sp-ag-2015-08-14.html

    I would like the RBA to push harder for declining UnN, but they don’t seem too bothered.

  9. Gravatar of Dan W. Dan W.
    9. September 2015 at 04:45


    Risky lending IS the problem. Risky lending blows bubbles which creates dislocations in the economy that result in recessions & depressions that require dramatic monetary intervention to repair.

    I agree with your thesis all the way up to your “wave of the hand” that it is a simple policy matter to manage lending risk. If only it were so. The truth is the Fed, since 2001, has boxed itself into a corner where the economy can only muster modest growth if the risk of debt is underpriced and if consumers are pushed to accept higher personal debt.

    On the other hand I highly agree with you that real growth is found in supply side reform. Where I differ in opinion is I believe economic policy (all of it including welfare, employment regulations, trade, etc) is far more important in the long run while monetary policy is mostly a slight of hand that pretends to be of importance to the common citizen but in truth is a sop to the banking cartel. Of course this is as it should be – the Federal Reserve knows who it is working for.

  10. Gravatar of ssumner ssumner
    9. September 2015 at 07:01

    Marcus, Very good post.

    Thomas, Good comment. I can be called a pragmatic libertarian of a right wing liberal. Just don’t anyone call me a conservative.

    Rajat, I tend to think money’s a bit too tight there, but I don’t really have a good grasp on the situation. For instance, I have no idea what Australia’s natural unemployment rate is.

    Dan, You said:

    “I agree with your thesis all the way up to your “wave of the hand” that it is a simple policy matter to manage lending risk.”

    I never made that claim. I said we should stop encouraging lending. It is a simply task to stop allow interest costs to be written off taxes, or to abolish Fannie and Freddie and FHA and FDIC.

    And sorry, but there is not a shred of evidence that financial problems cause recessions.

    You said:

    “Where I differ in opinion is I believe economic policy (all of it including welfare, employment regulations, trade, etc) is far more important in the long run”

    You really must no pay attention when you read my blog. That’s also my view.

  11. Gravatar of Brian Donohue Brian Donohue
    9. September 2015 at 10:29

    Good post, Scott.

    On the annoying subject of “fiscal must do its part”, I’ve got what seems to me a bit of a puzzler here (related to the USA):

    Federal government spending increased between FY 2014 and FY 2015 by about $250 billion (2015 dollars), a real increase of 7%.

    Now maybe I don’t understand how that Keynesian counter-cyclical thing works, but why would spending be increasing by 7% at this stage of the economic cycle? (In poking around, it looks like about half of this was due to ACA.)

    Despite an increase in revenue of $150 billion, the deficit (deficit, not debt) is up $100 billion this year.

    Fiscal policy is relentless, addictive. It’s like crack.

  12. Gravatar of ssumner ssumner
    10. September 2015 at 10:04

    Brian, Are you sure? These numbers suggest otherwise:


Leave a Reply