Macroeconomic mistakes

The last few decades have seen a fairly good run for macro-economics in Australia. That may be coming to an end.

Rudd recently ran over to the UK to have a talk-fest with the other neo-socialists about how the government can spend us out of a recession. This will leave us with bigger government, worse government and more political risk… and it won’t work.

One of the reasons that government spending won’t work is that it will crowd out private investment, and we are seeing evidence of this now. With western democracies going on a borrowing binge, they are sucking up the available savings from the financial markets and leaving less for private investors to borrow. This is a classic case of crowding out, done on an international scale.

The consequence is that banks must pay higher interest rates to get money, and they pass this on to us as higher retail interest rates. When the big banks refused to pass on the recent 0.25% cut in official interest rates, the government was quick to complain. But it is the government’s fiscal policies (along with the high-spending ways of other western countries) that is causing the cost of finance to go up.

But that is only the first of the macro-economic mistakes going on now.

The RBA was right to cut interest rates to compensate for a reduction in bank lending, to ensure that the total ‘broad money’ stayed roughly constant. But I think they’ve gone too far now — by about 0.5%. That obviously means I don’t think they should cut rates any more.

My fear is that a loose monetary policy may lead to either inflation or another ‘bubble’, or both.

The problem with fiscal and monetary policy now is that we are getting political judgments, not economic judgments. Fiscal policy should be to maintain balance (while understanding that automatic stabilisers will lead to a temporary deficit). Monetary policy should be to maintain a roughly constant money supply so that the value of money is maintained. That’s all. The current trends towards macro-activism is dangerous.

18 thoughts on “Macroeconomic mistakes

  1. Monetary policy should be to maintain a roughly constant money supply so that the value of money is maintained.

    I agree that the goal should be to maintain a stable value of money. But without defining which measure of the money supply you are talking about it is hard to say whether the first half of your statement is accurate. We have seen an explosion of M0 in the USA and for the time being I’m not convinced that that is inconsistent with stable money. However I do suspect that it soon will be inconsistent with stable money unless they make some painful adjustments.

    My reckoning is that the USA will in the next few years encounter higher than usual interest rates, high inflation or both. They will also likely have higher taxes.

  2. If it costs the same or less to rent than it does to service the interest on a home loan then doesn’t that indicate that interest rates are too low? Which will lead to another housing bubble.

  3. If it is cheaper to rent than buy then I’d suggest that there is little incentive for house prices to bubble higher.

  4. Terje — for the sake of stable value of money, the important variable is “broad money”.

    Troy — nope. Lots of things go into determining market rents and interest rates and there is no “correct” level except the market clearing level.

    I don’t think we have much of a housing bubble in Australia. Our current economic problems have been imported from the US. If we do end up with a bubble, it will not necessarily be in housing.

  5. I’m truly shocked. LOL.

    The government will increase its top rate of income tax to a higher than expected 50 percent from next year, Chancellor Alistair Darling said on Wednesday as he delivered the government’s annual budget

    The tax band had originally been due to rise to 45 percent from 40 percent in April 2011 as Britain seeks to claw back lost tax revenue caused by a deep recession.

    The 50-percent rate will apply to any income above 150,000 pounds.

    “In November, I announced a new rate of income tax of 45 percent on incomes above 150,000 pounds — the top one percent of taxpayers,” Darling said in his budget speech.

    “In order to help pay for additional support for people now, I have decided that the new rate will be 50 percent and will come in from next April — a year earlier.”

    In summary:

    Spend like there’s no tomorrow and then soak the high income earners because of your mistakes.

  6. Wayne Swan was on the radio this morning defending deficits. He said those that oppose deficits would want him to either cut spending or increase taxes and either initiative would be mad during a recession. So we know what he thinks of the British.

  7. What’s wrong with cutting spending? They could afford to lose some beef in the government offices I’ve seen

  8. I would be interested to hear what the thoughts are here on the First Home Owners Grant. Has it caused or is it causing an increase in prices for the bottom end? Has it caused or is it causing lower income people to take on loans they can’t afford? I guess my question is this; is there an artificial bubble in the making caused by the FHOG that will pop once the demand stops and when interest rates rise or unemployment increases?

    Would be grateful if anyone could share thoughts on this.

  9. The experts suggest Australia has an underlying shortage of housing based on fundamentals ie demand (including immigrants etc) and supply (construction rates etc). The main reason this is not pushing up prices is because of the credit shortage and concerns about unemployment.

    If that’s the case, then a housing bubble is definitely a possibility once the recession ends and confidence returns. With many people scared off the share market, there will be investor interest as well as owner-occupiers. Low interest rates will contribute.

    If Rudd’s still around, no doubt we will get an over-reaction that makes it worse then too.

  10. One reason given for why house prices in Australia are unlikely to fall is because of a high level of unmet demand.

    However, Dan Denning of the ‘Daily Reckoning’ recently wrote the following:

    “The Great Australian Property Price Crash is coming people. You can’t have a depression in credit and expect inflated housing values to magically levitate. The latest figures on housing and commercial finance show a few things. They show that first-home buyers are propping up the market while investors flee (as was the case in the U.S. in 2006). And they show that bank-lending to the private sector (both fixed loans and revolving credit) is retrenching.

    But what about the great supply deficit? Ms. Ellis [RBA economist] cites a report by the National Housing Supply Council. This “State of Supply” report is prepared by a committee of insiders from the building, banking, and real estate industries. You’d naturally expect them to conclude that the supply gap is large and growing.

    Yet this is not exactly what they’ve done. They’ve confessed that their estimates of housing demand are based on statistical models. To quote directly, “The Council estimates that a minimum of around 85,000 dwellings is the gap (unmet need) in the supply of housing in 2008. This is based on the incidence of homelessness and the low level of vacancy rates in the private rental market.”

    And you thought we were joking about the homeless. We’ve always said if there was really a supply problem, you’d see more homeless people. The estimate the Council comes up with for the gap assumes, we assume, that the homeless are homeless because there aren’t enough houses. This is nonsense. Studies show that a fair portion of the homeless choose to be homeless, or would be homeless regardless of historically low mortgage rates.

    But that point aside, low rental vacancy rates are also cited as evidence of a gap. This is nonsense too. Couldn’t this also be the fact that so many Australians live in capital cities? And so many of them want to live in the same place? It’s not that there aren’t places to live. It’s that everyone wants to live in the same place, which violates the laws of physics, of social propriety, and also drives up rents).

    In other words, maybe the two factors the Council cites in fabricating a housing gap have other, better explanations that a fictional shortage of housing. But maybe that narrative doesn’t suit the needs of people who make money selling houses.

    Ah! A caveat arrives on cue!

    “The Council acknowledges the crudeness of this [housing supply gap] estimate and also points out that there were some 830,000 vacant dwellings in Australia at the time of the 2006 Census. The Council has assumed that most of these were probably second homes, homes in the process of sale or homes awaiting redevelopment and that there is likely to be limited capacity for absorbing growth in underlying demand within the present level of housing supply.”

    Baffling. Or just deliberate chicanery?

    There are 830,000 vacant dwellings. But that, according to the Council, is not enough to meet the housing supply gap of just 85,000 dwellings? Math was never our strong suit. But this smells fishy…”

  11. Interesting stuff. I also read somewhere that loan to income ratio’s are at higher than usual levels which might cause some problems down the track too.

  12. Aaarg I just read my comment again and I got it the wrong way around.

    What I should have said…

    If it costs the same or MORE to rent than it does to service the interest on a home loan –> property bubble

    I get what you’re saying though thanks

  13. There is a potential property bubble developing particularly with the first home owners grant. It’s an optical illusion as prices in that bracket have already gone up to compensate for the higher government gift.

    The problem arises with the fact that unemployment even by SwanDive’s (non-admission) admission is heading to 10%. If we get to 10% a good umber of these people are going to lose their jobs and then what?

  14. David L: I am suspicious about migration being a serious factor. I’ve seen well researched and verified stuff that says that immigration, even very loosely regulated immigration does or would lower commodity prices because of increased specialisation – to the extent that this outweighs land price increases.

    Troy – I think you are possibly correct. But the rent/buy decision is a little more complex than comparing mortgages to rent. Rent has an option value, mortgages are a commitment and require you to go long on the market. Rents and mortgages might have a negative relationship, but they might also have a positive one since an objective valuation would be driven in either case by scarcity.

    We should be crapping ourselves:

    Skeptic: Have you tried simply trawling through the ALS, Catallaxy, etc?

  15. Jaz – i talked to a mate of mine this morning who works as a mortgage broker and he’s inundated with applications at the moment which he puts down to the increase in the fhbg. These are probably keeping house prices in the lower range up – sales of top end places, eg multi-million dollar houses in Mosman have dropped through the floor.

  16. My property valuer friend is saying the same thing Greego. He says the FHOG is keeping his work steady but is very anxious about how things will go after that stops.

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